RISKS AND RATING AGENCIES
Credit ratings are awarded to issuers on the basis of their credit worthiness. The highest ratings are generally assigned to countries and those bodies authorised by the State to issue securities. Large companies are also generally assigned high credit ratings (according to the volume traded and their reputation).
The lowest ratings are assigned to high risk issues, i.e. those carried out by issuers who are more likely to default. High yield bonds are generally those placed on the market by issuers with a low credit rating.
These ratings are important as lower rated issuers are forced to come to the market with a higher coupon and therefore incur a higher payout.
They tend to be calculated using public debt bonds as a benchmark with the difference between sovereign bond yields known as the quality risk premium. This fluctuates according to investors’ risk perception.
During times of uncertainty or crises, investors tend to turn to public bonds with lower risk. This is known as flight to quality.
Moody’s, Standard & Poor’s and Fitch are the main rating agencies and their rating systems use a combination of letters and numbers. The highest bond rating is Aaa (Moody’s) and AAA (Standard&Poor’s (S&P)) A CCC or Caa rating is considered very speculative with serious risk of default and great uncertainty; a CC rating is given when an issuer defaults on one coupon payment and a DD rating when there have been various defaults.