Bond Ratings
by MaestriSince the early 1900s, bonds have been assigned quality ratings that reflect their probability of going into default. The three major rating agencies are Moody’s Investors Service (Moody’s), Standard & Poor’s Corporation (S&P), and Fitch Investors Service. Moody’s and S&P’s rating designations are shown in Table 4-1.14 The triple- and double-A bonds are extremely safe. Single-A and triple-B bonds are also strong
enough to be called investment grade bonds, and they are the lowest-rated bonds that many banks and other institutional investors are permitted by law to hold. Double-B and lower bonds are speculative, or junk bonds. These bonds have a significant probability of going into default. A later section discusses junk bonds in more detail.
Representatives of the rating agencies have consistently stated that no precise formula is used to set a firm’s rating; all the factors listed, plus others, are taken into account, but not in a mathematically precise manner. Nevertheless, as we see in Table 4-2, there is a strong correlation between bond ratings and many of the ratios described in Chapter 10. Not surprisingly, companies with lower debt ratios, higher cash flow to debt, higher returns on capital, higher EBITDA interest coverage ratios, and EBIT interest coverage ratios typically have higher bond ratings.
Taken From : Five-Minute MBA – Corporate Finance
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