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Bond rating agency

A bond rating agency is a firm that specializes in rating debt instruments. The usual firms include Standard and Poor's, Moody's, and Fitch.

Expanded Definition

Several rating systems are used, but the most common bond rating ranges from AAA for the safest to C- for the least secure. Bonds rated D are already in default. Investment grade bonds are rated from AAA to BBB-. BB+ and below bonds are considered junk bonds.

The rating is assigned based on the expected ability of the issuing agency to refund the borrowed funds at maturity. The firms monitor the financial condition of the issuers and may issue credit watches or downgrade the ratings of their debt instruments if the financial conditions deteriorates. They may also upgrade ratings when the financial condition of the issuer improves.

Because bond rating is a key factor in determing the interest rate and hence the market value of the security, a ratings change is a significant event. The result can be capital gains or losses for bond traders.

Bond rating agencies have been in the news recently in connection with the subprime mortgage debacle. They rated mortgage securities AAA on the theory that real estate declines are rarely national, and most investors are diversified enough to withstand declines in a few regions at a time. That assumption proved to be disasterous.

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