credit rating

Examples of credit rating in the following topics:

• Bond Rating System

  • The credit rating is a financial indicator assigned by credit rating agencies; bond ratings below BBB-/Baa are considered junk bonds.
  • In investment, the bond credit rating assesses the credit worthiness of a corporation's or government's debt issues.
  • It is analogous to credit ratings for individuals.The credit rating is a financial indicator to potential investors of debt securities, such as bonds.
  • Moody's assigns bond credit ratings of Aaa, Aa, A, Baa, Ba, B, Caa, Ca, C, with WR and NR as withdrawn and not rated.
  • Standard & Poor's and Fitch assign bond credit ratings of AAA, AA, A, BBB, BB, B, CCC, CC, C, and D.

• Ratings

  • Bond credit rating agencies assess and report the credit worthiness of a corporation's or government's debt issues.
  • In investment, the bond credit rating assesses the credit worthiness of a corporation's or government's debt issue.
  • The credit rating is analogous to a credit rating for individuals.
  • These are bonds that are rated below investment grade by the credit rating agencies.
  • Credit ratings are used to report on the credit worthiness of a bond issuing company or government

• International Credit Rating Agencies

  • International credit-rating agencies do not focus on risk for particular companies but assess investment risk associated with countries.
  • Two well-known credit agencies are A.M Best and Coface.
  • Table 2 shows a country's rating for 2012.
  • Coface, France's export credit underwriter, is another international credit-rating agency.
  • Table 3 shows Coface's 2012 rating of countries.

• Securitization and the 2008 Financial Crisis

  • Each tranche has a bond associated with a risk level and a different credit rating.
  • Credit-rating agencies could rate some bonds as AAA that pays the lowest return to investors, but investors are first in line if the fund goes bust.
  • Credit agencies always rated CDOs with an AAA credit rating, even though some CDO's funds contained subprime mortgages.
  • Credit-rating agencies were either incompetent or perpetuating fraud.
  • The AAA credit rating became vital for bankers to sell the CDOs.

• Price Risk

  • Interest rates and bond prices carry an inverse relationship.
  • Fixed-rate bonds are subject to interest rate risk, meaning that their market prices will decrease in value when the generally prevailing interest rates rise.
  • When the market interest rate rises, the market price of bonds will fall, reflecting investors' ability to get a higher interest rate on their money elsewhere — perhaps by purchasing a newly-issued bond that already features the new higher interest rate.
  • On the flip side, if the prevailing interest rate were on the decline, investors would naturally buy bonds that pay lower rates of interest.
  • Bond prices can become volatile depending on the credit rating of the issuer – for instance if the credit rating agencies like Standard & Poor's and Moody's upgrade or downgrade the credit rating of the issuer.

• Chapter Questions

  • You had purchased bonds from a country with a CCC credit rating.
  • interest rate you would charge if a comparable U.S.
  • Please explain whether or not the Risk Rating System is objective?
  • How would you rate Hong Kong using A.M.
  • How would you rate the Ukraine using A.M.

• Answers to Chapter 10 Questions

  • Banks use credit risk analysis, collateral, credit rationing, and restrictive covenants to reduce adverse selection.
  • Floating rate debt is loans with a variable interest rate.
  • If the interest rate increases, then borrowers must pay more interest on their payments.
  • A fund offers different tranches with different credit ratings and rates of return.
  • If banks retained their rigid lending standards and the creditrating agencies accurately rated the CDOs and ABS, then the housing bubble would still form but at a slower rate.

• Measuring Country Risk

  • Investors protect themselves from credit risk by increasing the borrower's interest rate.
  • Consequently, credit-rating agencies measure a borrower's risk.
  • Analysts and economists measure a country's risk similarly, applying the same credit rating rules.
  • Furthermore, a credit-rating agency rated the Mexican government a letter grade of BBB that equals a spread of 140 basis points (bps).
  • We show a country's credit rating and spread in Table 1.

• Evaluating Interest Rates

  • The return expected on debt depends upon the credit rating of the company, which takes into account a number of factors to determine how risky loaning funds to a company will be.
  • Debtors management involves identifying the appropriate credit policy -- i.e. credit terms which will attract customers -- such that any impact on cash flows and the cash conversion cycle will be offset by increased revenue and, hence, return on capital (or vice versa).
  • If inflation is at a high level or there are opportunities foregone because of lack of working capital, a firm will more than likely have a stricter credit policy.
  • Interest rates of working capital financing can be largely affected by discount rate, WACC and cost of capital.
  • Evaluate a company's interest rates based on its stage of development

• Depository Institutions

  • During the early 1980s, many savings institutions experienced financial crisis because of higher interest rates.
  • For example, if you borrowed $10,000 at a 5%, interest rate and loaned it out at 10%, then you earn a profit.
  • However, if you borrowed $10,000 at 10% interest rate and loaned it out at 5%, subsequently, you earn a loss.
  • Interest rates rose during the 1980s as the savings institutions paid a greater interest rate to thedepositors than the amount of these institutions earned on the mortgages. mortgages are usually 30-year loans, and savings institutions were locked into low interest rates from the 1960s.
  • Credit unions are another depository institution.