Further, both systems clearly have boundary lines established
with the BBB and Baa rating, which in the first category is
indicating some speculative investment characteristics.
So bonds above BBB- are believed to be safe investments, and
therefore are called investment grade.
While bonds below BBB-, that is BB+, BB and so on,
should basically receive a very careful analysis of
the risk because they're inherently more speculative
than bonds which have a rating of BBB- and above.
So Baa ratings are more than, and
basically bond ratings are a lot more than just symbols, okay?
They are gauges of risk, and in the marketplace investors
almost always demand greater returns as risk increases.
Therefore, the lower an issuer's rating,
the greater the annual interest payments that is demanded.
Now since ratings can translate into millions of dollars of interest savings
for the corporation, rating agencies are understandably very careful and
thorough in pronouncing their opinions on default risk, which is what ratings are.
So each rating agency employs a staff of security analysts, who examine
the financial condition, the operations, and the management of a given issuer.
They also study specific documents such as the bond indenture,
which describes certain legal and technical details of the issue.
Perhaps the most important factor is the evaluation of the company's
future earning potential.
Now, in general, bond analysts test and
issue a strength under adverse market conditions with
an objective to determine the safety of the principal and interest payments.
So, therefore, after rating is given, it is typically reviewed periodically, and
is sometimes changed to reflect any improvement or
deterioration in an issuer's overall condition.
So, just to sum up, essentially,
as individual bond investors, we don't have the bandwidth or
the skill set to analyze the risk of default of each issuer,
be it a corporation or an agency or a municipality.
So therefore, the rating agencies do the job for us in trying to do an objective
assessment of the risk of the IOUs, which are what bond payments are all about.
So rating agencies make the job easier for investors to assess the risk.
And based on the risk assessment, typically if the bond is more risky,
i.e., has a lower rating, then the coupon on the bond is typically higher.
Similarly, the most risk free bonds, which have a rating of,
say, AAA tend to have the lowest coupon.
Be that for, and this is true globally not just in the US.
It's true for all countries in which bonds are issued and traded.
Please note that most of the ratings are country specific,
so a AAA rating in a country like, say, India or
China is not necessarily directly comparable to a AAA rating in the US.
So, for instance, if the US Treasury has rating of AAA, and
the Indian government securities also has a AAA,
that doesn't necessarily mean that these two AAA are comparable.
So you normally have ratings assigned in a particular country.
And it's better to basically compare ratings in a given country and
definitely in a given currency than comparing it
across different countries and different currencies.