What is a credit rating?
Everyone who has ever borrowed money will have a rating, or credit score, that gauges their creditworthiness, and it may change over time. But the ratings that interest financial markets are those that are awarded to large corporations, municipal bodies and sovereign governments.
Where have you heard about credit ratings?
When countries such as Britain, France and the US lost their top-quality AAA credit ratings in the wake of the financial crisis, this made headlines round the world. Credit ratings affect the rate of interest that will be charged on an issuer's bonds.
What you need to know about credit ratings...
Three major agencies dominate the ratings business; Moody's, Standard & Poor's, and Fitch. Each has a slightly different grading system, but, in general, AAA is the highest and anything from the lower Bs downwards designates junk-bond status. D refers to bonds whose issuers are in default.
If a debt has a high credit rating it means that it's highly likely that the company or government issuing it will be able to pay it back in time, so it's a relatively safe, but normally lower return, investment. Lower-rated debt is for experienced speculative investors only who are prepared to take more risk in return for the higher yield on these bonds.
Although the agencies are paid by the corporations, entities or governments they are rating, they're duty bound to objectively review their financial health and their ability to repay the debt after conducting proper due diligence. For this reason, they were criticised in the wake of the 2008 financial crisis for having given misleadingly high ratings to unsound investments.