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How do Credit Ratings work?

Credit Ratings are a good guide to the 'risk' involved in a financial security.  While there has been controversy during the Global Financial Crisis about the value of these credit ratings, they are still a valuable tool to assess the 'quality' of an investment that you are looking at making.

There are three main credit rating firms.  Each has their own methodology and they all use different rating systems.  Therefore, when you are assessing an individual security, it is important that you understand WHO has rated the security, and WHAT the rating means.

It is also important to understand that the more letters of the same kind the higher ranking.  For example a AA is higher than an A+.  AAA- is higher than a BBB+.

Here are the websites for each of the main rating firms.

Standard & Poors website                                                                14 01 SP_CreditRatingsGuide 20 pages

Moodys website                                                                      14 Moodys Rating Symbols and Definitions 46 pages

Fitch website                                                                       14 Fitch ratings definitions and scales 61 pages

For a quick reference to compare the different rating systems - here is a table courtesy of Wikipedia (with all the normal disqualifiers of accuracy and completeness)

Moody'sS&PFitchrating description
Long-termShort-termLong-termShort-termLong-termShort-term
AaaP-1AAAA-1+AAAF1+Prime
Aa1AA+AA+High grade
Aa2AAAA
Aa3AA-AA-
A1A+A-1A+F1Upper medium grade
A2AA
A3P-2A-A-2A-F2
Baa1BBB+BBB+Lower medium grade
Baa2P-3BBBA-3BBBF3
Baa3BBB-BBB-
Ba1Not primeBB+BBB+BNon-investment grade
speculative
Ba2BBBB
Ba3BB-BB-
B1B+B+Highly speculative
B2BB
B3B-B-
Caa1CCC+CCCCCSubstantial risks
Caa2CCCExtremely speculative
Caa3CCC-Default imminent with little
prospect for recovery
CaCC
C
CD/DDD/In default

 

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