Credit Rating
A credit rating is an agency's opinion of how able and willing a borrower — a government, company or other issuer — is to repay its debts on time. Letter grades like AAA to D summarise default risk and strongly influence borrowing costs.
Before lending money, investors want to know how likely they are to get it back. Credit rating agencies such as S&P, Moody's and Fitch publish grades that answer that question in shorthand. A downgrade can raise a company's borrowing costs overnight. This entry explains rating scales, what moves ratings and their limits.
- Category
- Bonds and Interest Rates
- Reading time
- 3 min
- Also called
- Bond rating, Credit score (corporate), Sovereign rating
- Updated
Credit ratings in plain words
A credit rating is an agency's opinion of an entity's ability and willingness to meet its financial obligations in full and on time.1
S&P treats bonds rated BBB− or higher as investment grade; Moody's uses Baa3 or higher.2
S&P's scale runs from AAA (best) to D (worst), and bonds rated BB or below are not investment grade.3
How ratings work, step by step
An issuer requests a rating
Usually when selling bonds. See Bond.
The agency analyses
Finances, debt, industry, management.
A grade is assigned
E.g. AA, BBB, B.
Outlook is set
Positive, stable or negative.
Ratings are monitored
Upgrades or downgrades follow changes.
Markets react
Yields adjust to the risk. See Credit Spread.
Worked examples
Example 1 — Borrowing cost
Costlier debtAn AA-rated company borrows at 4.5%; a BB-rated company at 7.0%.
| Difference | 250 bps |
| On $100m | $2.5m more interest a year |
Lower ratings mean higher perceived default risk, so investors demand higher yields. See High-Yield Bonds.
Example 2 — Falling angel
Fallen angelA company is downgraded from BBB− to BB+.
| Status | Investment grade → high yield |
Dropping below BBB− removes investment-grade status on the S&P scale.2
Example 3 — Price impact
≈ −6%After a downgrade, a bond's yield rises from 5% to 6%; its duration is 6.
| Approximate price change | −6 × 1% = −6% |
Higher required yields push bond prices down. See Interest Rate.
Rating scale (S&P / Moody's)
| Aspect | S&P | Moody's |
|---|---|---|
| Highest | AAA | Aaa |
| Lowest investment grade | BBB− | Baa3 |
| Highest high yield | BB+ | Ba1 |
| Default | D | C |
How ratings are used
Bond pricing
Ratings shape yields. See Yield to Maturity.
Investment rules
Many funds can only hold investment grade. See Investment Grade.
Bank capital
Ratings affect regulatory capital.
Sovereign risk
Country ratings move currencies. See Currency Risk.
Advantages and disadvantages
Advantages
- Quick summary of credit risk.
- Standard, comparable scales.
- Widely used by investors and regulators.
Disadvantages
- Ratings can lag reality.
- Issuer-pays model creates conflicts.
- Agencies have made major mistakes, as in 2008.
Going deeper
Read as far as you need. Each level builds on the one before it.
Who is rated
Beginner
Ratings apply to governments, businesses and other borrowers that issue debt.1
Default risk
Intermediate
Bonds rated BB or lower are considered riskier because of the relative potential for issuer default.3
Spreads lead ratings
Advanced
Markets often move credit spreads before agencies change ratings, so spreads are a timelier risk signal. See Credit Spread.
Common mistakes
Treating ratings as guarantees
Even AAA debt has defaulted.
Ignoring outlooks
Negative outlooks warn of downgrades.
Relying only on ratings
Do your own analysis. See Altman Z-Score.
Mixing scales
S&P and Moody's use different symbols.
Check your understanding
Test yourself before moving on. Each answer comes with an explanation.
Key points to remember
- Credit ratings judge ability and willingness to repay.
- Scales run from AAA to D.
- BBB−/Baa3 is the investment-grade cutoff.
- Downgrades raise borrowing costs.
- Ratings can lag market signals.
Frequently asked questions
Who are the main rating agencies?
Who pays for credit ratings?
Do ratings change often?
Further learning
- Investment Grade
The higher-rated tier.
- High-Yield Bonds
The lower-rated tier.
- Credit Spread
The market's view of risk.
- Default Risk
What ratings measure.
Sources
This article is written in our own words. The sources below support the specific facts, rules and figures marked with a number in the text. Links open the original publisher’s page.
- Corporate Finance Institute. Credit Rating (opens in a new tab) Checked .
- Corporate Finance Institute. Investment-Grade Bonds (opens in a new tab) Checked .
- FINRA. Bonds (opens in a new tab) Checked .
Educational content, not financial advice. Examples use hypothetical prices and simplified costs; actual fees, margin rules and regulations vary by broker, market and country. We are not affiliated with any publisher linked above. Last reviewed . Report an error or request a source credit.