What is a credit rating and what does it tell you about an investment?

Julie Brownlee, Fsp Invest, 06 Oct. 2014

Tags: credit rating, what is a credit rating, credit rating agencies, credit ratings, bonds,

Since the collapse of African Bank Investments, you may have seen the credit rating downgrades of many of South Africa’s banks.

Downgrades to credit ratings are generally not good news for the relevant company.

The lower the credit rating, the higher the risks involved with the specific company or government.

So what exactly is a credit rating? And should you pay attention?

Read on to find out…

What is a credit rating?

A credit rating is an assessment of a borrower to pay interest on a loan and eventually pay the loan bank.

The borrower can be an individual, a company or a government.

When you apply for credit with your bank, for example, they’ll rate your credit score and assign a relevant credit rating.

But if you’re a company or a government, there are other agencies at work…

Who are the credit rating agencies?

Credit rating agencies include companies like Standard & Poor’s, Moody’s or Fitch. They give companies and governments credit ratings on their bonds. That is, the money they borrow through issuing bonds.

To determine a credit rating, these agencies look at the strength of a company’s business or a country’s economy and its borrowings in relation to its income.

If an economy or company is strong and has a stable income to easily pay the interest and the loan, it will gain the highest credit rating, like AAA.

If an economy or company is weak and its income isn’t stable, the lower the credit rating will be. A lower credit rating means there’s a higher risk of the company or government defaulting on their debt.

What are the best credit ratings?

AAA to BBB are investment grade credit ratings. The agencies see these bonds as being relatively safe.

If a bond has a rating of BB or below, the agencies see these bonds as sub-investment grade, speculative, high yield or junk bonds. In other words, more risky.

Credit ratings are very important as they can have an effect on the rate of interest a company or government has to pay.

So there you have it, what a credit rating is and what it tells you about an investment.

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