Definition
Standard & Poor’s Rating (S&P Rating) is a classification system developed by the Standard & Poor’s Corporation to evaluate the creditworthiness and risk associated with different stocks and bonds. The ratings provide investors with insight into the potential risk of default on the timely payment of interest and principal.
Rating Categories
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Investment Grade: This category signifies a lower risk of default. It includes:
- AAA: Highest quality, minimal credit risk.
- AA: High quality, very low credit risk.
- A: Strong ability to meet financial commitments, but more susceptible to adverse economic conditions compared to higher-rated categories.
- BBB: Adequate protection parameters, but susceptible to adverse economic conditions and changes in circumstances.
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Speculative Grade: This category indicates higher risk and includes all ratings below BBB. Fiduciaries are typically not permitted to invest in speculative grade securities. The speculative grades include:
- BB: Less vulnerable in the near-term but faces major ongoing uncertainties and exposure to adverse financial conditions.
- B: More vulnerable to adverse financial conditions but currently has the capacity to meet financial commitments.
- CCC: Currently vulnerable and dependent on favorable economic conditions to meet obligations.
- CC: Highly vulnerable, possibly in default on some obligations.
- C: Extremely vulnerable, often in default.
Examples
- AAA Rating: A government bond from a country with a stable, strong economy, like the United States or Germany.
- BBB Rating: A corporate bond from a well-established company but with some level of economic or business volatility.
- BB Rating: A bond from a company in an emerging market with higher economic risk.
Frequently Asked Questions
What is the purpose of Standard & Poor’s ratings?
The primary purpose is to assess the credit risk of a security (bonds or stocks) and provide investors with a clear indication of the likelihood of receiving their expected interest and principal repayments.
Who uses S&P ratings?
Investors, fund managers, financial advisors, and fiduciaries use these ratings to make informed investment decisions and manage portfolio risks.
Are S&P ratings mandatory for all bonds?
No, obtaining an S&P rating is typically voluntary, but issuers often seek ratings to reassure investors and potentially secure lower borrowing costs.
How often are S&P ratings updated?
S&P continuously monitors rated entities and updates the ratings as necessary based on new financial data or changes in market conditions or business environments.
What happens if a bond rating is downgraded?
A downgrade can indicate increased risk, potentially leading to higher borrowing costs for the issuer and decreased market price for the bond. It may affect the investment decisions of those holding the bond.
Related Terms
Investment Grade
Investments that have a low risk of default, rated BBB or higher by S&P.
Speculative Grade
High-risk investments rated below BBB by S&P, also known as non-investment grade or junk bonds.
Credit Risk
The possibility that a borrower will default on their debt obligations.
Fitch Ratings
Another major credit rating agency alongside S&P and Moody’s, providing similar ratings and risk assessments.
Moody’s Investors Service
A global credit rating agency that offers credit ratings and risk analysis, similar to Standard & Poor’s.
Online References
Suggested Books for Further Studies
- “Bond Credit Analysis: Framework and Case Studies” by Frank J. Fabozzi
- “The Handbook of Fixed Income Securities” by Frank J. Fabozzi
- “Credit Risk Modeling: Theory and Applications” by David Lando
Fundamentals of Standard & Poor’s Rating: Finance Basics Quiz
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