Why a country’s or company’s credit rating is so important

Julie Brownlee, Fsp Invest, 08 Jun. 2015

Tags: credit rating, credit ratings, what is a credit rating, importance of credit rating, bonds



On Friday, ratings agency Fitch revealed it wasn’t going to downgrade South Africa’s credit rating as many traders and investors had feared.

The impending decision was responsible for a lot of pressure on the rand last week.

So what is a credit rating? And why are credit ratings so important?

Read on to find out…



What is a credit rating?


A credit rating is an assessment of the ability of a borrower to pay interest on a loan and eventually pay the borrowed money back.

If you apply for a loan from the bank, the bank will check your credit rating using credit rating agencies.

When companies and governments want to raise money, they issue bonds to investors. So investors can assess the risks involved, companies and governments pay credit rating agencies to give their bonds ratings.

Rating agencies include the likes of Standard & Poor’s (S&P), Moody’s and Fitch.


How a credit rating works


Rating agencies look at a number of factors to determine a company’s or government’s credit rating.

These factors include:

  • The strength of a company’s business or a country’s economy.
  • Its borrowings in relation to its income.

If a country’s economy is strong or a company has a stable income to cover interest payments and looks highly likely to pay back the loan, it will achieve the highest rating from an agency. This is AAA from S&P and Fitch, and Aaa from Moody’s.

If the ability to pay back interest and the loan is weaker, the lower the credit ratings the agency will award. This means there’s a higher chance of the country or company defaulting on its debt.


The importance of a credit rating


Investment grade
If a country or company achieve this, they are relatively safe investments.

This covers AAA to BBB- with S&P and Fitch, and Baa3 with Moody’s.

Sub-investment grade
This grade is a speculative grade, and include high yield and junk bonds.

This covers BB+ with S&P and Fitch, and Ba1 with Moody’s.

Credit ratings are very important as changes to them can result in a chance in the interest rates a company or government pays.

So there you have it. Why a country’s or company’s credit rating is so important.

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