What is Credit Rating?
Credit ratings are the bond market's report card — a standardized way to evaluate default risk. A AAA rating means near-certain repayment; a BB rating means significant risk. The rating determines how much yield investors demand.
A credit rating is an assessment of a bond issuer's ability and willingness to meet its debt obligations. Ratings are assigned by agencies like S&P, Moody's, and Fitch using letter grades from AAA (highest quality) to D (default). Ratings directly affect bond yields — lower ratings mean higher yields to compensate for default risk.
The Rating Scale
Investment grade: AAA, AA, A, BBB — considered safe for institutional investors. Speculative grade (junk): BB, B, CCC, CC, C — higher default risk, higher yields. D means default. Each agency uses slightly different notation: S&P/Fitch use AAA; Moody's uses Aaa.
What Ratings Measure
Ratings assess probability of default and loss severity if default occurs. They consider: financial strength, cash flow stability, industry position, economic conditions, and governance. Ratings are opinions, not guarantees — agencies have been wrong before.
Impact on Bond Prices
Rating downgrades cause bond prices to fall (yields rise). Upgrades cause prices to rise. Crossing the investment-grade/junk threshold (BBB to BB) is especially impactful — many institutional investors cannot hold junk bonds, forcing sales.
Credit Rating Scales
| Grade | S&P/Fitch | Moody's | Meaning |
|---|---|---|---|
| Highest | AAA | Aaa | Extremely strong capacity to pay |
| High | AA+/AA/AA- | Aa1/Aa2/Aa3 | Very strong capacity |
| Upper Medium | A+/A/A- | A1/A2/A3 | Strong capacity |
| Lower Medium | BBB+/BBB/BBB- | Baa1/Baa2/Baa3 | Adequate capacity |
| Speculative | BB+/BB/BB- | Ba1/Ba2/Ba3 | Less vulnerable near-term |
| Highly Speculative | B+/B/B- | B1/B2/B3 | More vulnerable |
| Substantial Risk | CCC to C | Caa to C | Currently vulnerable |
| Default | D | C | In default |
Practical Example: Rating and Yield
German Bunds (AAA) yield 2.5%. A BBB-rated corporate bond with the same maturity yields 4.0%. The 1.5% spread compensates for default risk. If the corporate is downgraded to BB (junk), its yield might jump to 6% as institutional investors sell — even though nothing changed operationally.
Frequently Asked Questions
What is a credit rating in simple terms?
A credit rating is a grade that shows how likely a bond issuer is to pay you back. AAA is safest (like Germany); D means already defaulted. Higher risk = lower rating = higher yield.
Who assigns credit ratings?
The 'Big Three' agencies: Standard & Poor's (S&P), Moody's, and Fitch. They analyze issuers' financials and assign ratings. Issuers typically pay for ratings, which creates potential conflicts of interest.
Is Germany rated AAA?
Yes. Germany holds the top rating from all major agencies — AAA (S&P/Fitch) and Aaa (Moody's). This reflects its strong economy, fiscal discipline, and unbroken repayment history.
Can ratings change?
Yes. Agencies continuously monitor issuers and can upgrade or downgrade ratings. They also issue 'outlooks' (positive, stable, negative) signaling potential future changes.
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