How Do Credit Ratings Affect Yield?

The leading rating agencies assess most issuers of corporate bonds as to their ability and willingness to pay interest and repay principal as scheduled. These agencies use quantitative tools and qualitative judgments to evaluate the creditworthiness of an issuer and have developed a grading system from which they assign credit ratings to these issuers. Usually, only bonds issued by the largest and strongest companies qualify for the prized “investment-grade” ratings, which indicate outstanding relative credit. The highest-quality rating is triple-A. The rating levels descend to triple-C as the possibility of default increases and finally to D, or default. Bonds considered to carry minimal likelihood of default are “investment grade” and are rated Baa3 or higher by Moody’s, or BBB- or higher by Standard & Poor’s and Fitch Ratings. Those companies rated below Baa3 or below BBB- are considered “speculative grade.” They have a higher risk of default and are classified as high-yield bonds, as are some types of non-rated bonds. The table below describes the rating assignments for both investment-grade and below-investment-grade debt.