BAJAJ BROKING
March 07, 2025
7 mins read
A bond’s rating represents the creditworthiness of its issuer. In other words, it signifies whether its issuer can comfortably pay interest and principal due on his bond on time or not. Read more..If he can pay his obligations easily, his bond will get a high rating. Otherwise, it will get a low rating. As the risk is lower in bonds with higher ratings, they offer lower interest rates. On the other hand, bonds with lower ratings offer higher interest rates because they are riskier. Read less
Bond rating represents the credit quality of a bond. It shows a bond issuer’s ability to pay interest and principal on time. Hence, if an issuer can easily pay his obligations on time, his bond will get a high bond rating. Conversely, if an issuer is likely to face issues in meeting his obligations, his bond will get a low credit rating.
Such ratings are issued by credit rating agencies, like CRISIL, ICRA, and Fitch, which have expertise in this area. A bond’s rating is extremely important for investors, as it conveys to them vital information about risks associated with investments in the bond.
Bonds with high ratings make it easy for issuers to approach capital markets to raise funds because highly-rated bonds attract investors easily. Having learnt what bond rating is, let us delve deeper into this topic.
Bond ratings are important in capital markets for the reasons explained below:
Ratings enable investors to analyse a bond’s risk: Bond ratings help investors assess the risks inherent in a bond. Higher bond ratings mean lower risk, while lower bond ratings mean higher risk. Based on their assessment, investors can decide whether to invest or not in a bond. Investors do not always want to invest in bonds with high credit ratings. They can also consider investing in bonds with low credit ratings. But, they may demand a high interest rate to do so.
Ratings help bond issuers access the market: Bond ratings are issued by independent credit rating agencies, which have nothing to do with issuers. Such independent assessment of an issuer’s creditworthiness builds confidence in the market. Hence, if a bond has a high rating, it tells investors that independent agencies think that the issuer can meet his obligations. So, the bond is worthy of investment. On the other hand, if a bond has a low credit rating, it conveys to investors that independent agencies do not think that it is worthy of an investment.
A bond’s rating depends upon many factors, which impact the creditworthiness of its issuer. An issuer’s financial strength is one of the most important factors that impact a bond’s rating.
To assess an issuer’s financial strength, an agency considers its financial statements, like the profit & loss account, balance sheet, and cash flow statement. Besides, it also considers many financial ratios while assigning a rating.
Economic conditions are another factor that impacts bond ratings. When an economy performs well, an issuer may find it easy to pay his obligations. However, when an economy goes through a crunch, it can make it difficult for bond issuers to pay their obligations.
The management of an issuer can also impact its bond’s ratings. The management and leadership of an issuer have a long-lasting impact on its performance. Hence, rating agencies consider this factor, too, while assessing a bond.
At times, bonds are backed by collateral or security. In such a case, an agency has to assess the quality of collateral/security while assessing the issuer’s creditworthiness.
Credit rating agencies use a letter scale to assign ratings to bonds. The higher the rating, the lesser the risk, and vice versa. Please refer to the following table to understand the meaning of bond ratings.
Bond Rating | Investment Grade / Non-Investment Grade | Meaning |
Investment Grade | This rating is given to a bond with minimal credit risk, which means there is a negligible risk that its issuer will default on its interest and payment. Hence, it is of high quality. | |
AA/Aa | Investment Grade | These are high-quality bonds with low credit risk. While they are riskier than bonds with AAA/Aaa rating, still the probability of their issuer defaulting is very low. |
A/A | Investment Grade | Such bonds carry some credit risk. In terms of quality, they belong to the upper medium category. |
BBB/Baa | Investment Grade | These bonds have moderate credit risk and hence are medium in quality. |
BB/Ba | Non-Investment Grade | From this rating onwards, we have non-investment grade bonds. Bonds rated BB/Ba have a higher risk of default. Hence, investments in them is considered speculative. |
B/B | Non-Investment Grade | These bonds are vulnerable to default and hence have a considerable credit risk. |
CCC/Caa | Non-Investment Grade | These bonds are likely to default. So, they have a very high credit risk. |
CC/Ca | Non-Investment Grade | These bonds are near the stage of default. The issuers of some of them may have already defaulted. |
C/C | Non-Investment Grade | These bonds are currently in default. Hence, they are non-investment grade. |
D | Non-Investment Grade | “D” is the worst possible rating a bond can get. It means that a bond issuer has failed to pay his obligations. |
The most important factors that influence a bond’s ratings are explained below:
Issuer’s creditworthiness: Whether a bond issuer is a government or a company, its creditworthiness is one of the most important factors that impacts a bond’s rating. A financially-stable issuer with high creditworthiness is able to get a high bond rating. Conversely, an issuer with low creditworthiness gets a low credit rating.
Changes in interest rates: At times, interest rates increase considerably, which affects an issuer’s ability to pay interest and principal on his debt. In such a case, his credit rating can get adversely affected. However, if interest rates decrease and improve an issuer’s creditworthiness, then his credit rating can improve.
Economic scenario: If there is a lot of uncertainty about inflation rate, interest rate, GDP growth, and unemployment, it can badly affect an economy to such an extent that a bond issuer may struggle to pay his obligations, which can affect his bond’s ratings.
Industry risk: At times, an industry goes through changes, which affect companies within that industry favourably or unfavourably. Let us take the case of an export-oriented industry. If Indian Rupee depreciates, the value of its sales in local currency will decline, which will affect all the companies from the industry. Hence, their credit ratings could get impacted as well.
If you are an investor, you must consider bond ratings while formulating your strategy for various reasons. First, such ratings can help you assess the risk inherent in a bond. A risk-averse investor should consider only those bonds that have investment-grade ratings.
Second, bond ratings can also help you diversify your portfolio. With the help of ratings, you can create a portfolio of bonds with different kinds of ratings and different kinds of yields to earn an optimum overall return on your portfolio.
Third, bond ratings can help you determine which kinds of bonds will react more to interest rate changes. It is well-known that bond yields and bond prices move in opposite directions. However, when interest rates increase, bonds with low credit ratings show more sensitivity in their price than bonds with high credit ratings.
Investors who are not comfortable with excessive changes in the price of bonds should not park their funds in bonds with low credit ratings, especially when interest rates are likely to increase.
While bond ratings are a useful indicator, you need to be aware of their limitations to make an informed decision when investing. Such ratings tend to be subjective, as the rating criteria employed by different agencies could be different.
At times, bond ratings may not properly reflect an issuer’s current financial health because they are a lagging indicator. Hence, real-time changes in an issuer’s financial health may not be properly captured in his bond’s ratings. If due to certain reasons, his financial health is too erratic, then investors need to wait for the next rating update to make a decision.
There is no guarantee that a bond with a high rating will never default. An investor must bear in mind that a rating is an assessment, which could go wrong. Such assessments are based on the available data and the ability of an analyst to interpret the data. If the available data is not good enough or if an analyst is not capable enough, a bond’s rating may not be a realistic assessment of its issuer’s creditworthiness.
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A bond’s rating represents the creditworthiness of its issuer. In other words, it tells us whether an issuer will be able to pay interest and principal due on his bonds comfortably or not.
Bond ratings in India tend to be dynamic. They usually change based on data released by companies every quarter. Apart from that, factors like market conditions, global & local economy, and company updates can also make an agency change bond ratings more frequently than once in a quarter.
Yes, bond ratings can certainly change over time due to a variety of factors, like changes in an issuer’s financial health, economic factors, industry factors, etc.
Investment-grade bonds have a higher credit rating (BBB/Baa or above). Hence, investments in them are more stable, as the risk is lower. However, junk bonds have a lower credit rating (BB/Ba or lower). So, investment in them is unlikely to be stable, as the risk is higher.
Bonds with higher ratings are perceived as safe investments. Hence, they offer lower interest rates. On the other hand, bonds with lower credit ratings are seen as risky. So, they offer higher interest rates.
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