What Is a Bond Rating?
Let me explain bond ratings directly: they're assessments by rating agencies that show how likely a bond issuer is to repay their debt on time, represented through a letter grade.
A bond rating measures the creditworthiness of a bond, which directly affects the borrowing costs for the issuer. These ratings assign letter grades to indicate credit quality.
Independent services like S&P Global Ratings, Moody’s Ratings, and Fitch Ratings evaluate the issuer's financial strength and their ability to pay principal and interest promptly.
How Bond Ratings Work
You should know that most bonds get ratings from at least one of the three main agencies: S&P Global Ratings, Moody’s Ratings, or Fitch Ratings.
These agencies perform a detailed financial analysis of the issuer, whether it's U.S. Treasuries or international corporate bonds.
Using their specific criteria, analysts assess the entity's bill-paying ability, liquidity, and future outlook, then assign an overall rating based on that data.
This rating helps you, as an investor, evaluate the bond's risk and default potential. Higher-rated bonds are safer with lower yields, while lower-rated ones are riskier but offer higher returns.
Pricing, Yield, and Long-Term Outlook
Bond ratings are crucial for informing you about a bond's quality and stability, which in turn affects interest rates, investor interest, and pricing.
Higher-rated, investment grade bonds are seen as safer and more stable, often linked to strong corporations or governments with positive outlooks.
These include ratings from AAA to BBB- from S&P and Fitch, or Aaa to Baa3 from Moody’s. Yields typically rise as ratings drop within this category, with U.S. Treasury bonds being a prime AAA example.
Non-investment grade or junk bonds carry ratings like BB+ to D from S&P and Fitch, or Baa1 to C from Moody’s, sometimes even unrated. They attract investors with high yields despite risks like liquidity problems and potential default.
Recent Downgrades and Historical Context
Consider this important update: In August 2023, Fitch downgraded the U.S. long-term rating to AA+ from AAA due to expected fiscal deterioration, rising debt, and governance issues leading to debt limit standoffs.
Then in May 2025, Moody’s downgraded it from Aaa to Aa1, citing higher government debt and interest payments compared to peers.
Looking back, rating agencies played a key role in the 2008 financial crisis. Many believe they contributed by providing inflated ratings, often through bribes, which overvalued securities.
For instance, in 2008, Moody’s downgraded 83% of $869 billion in mortgage-backed securities that had been rated AAA just a year earlier.
Why Lower Ratings Mean Higher Yields
Bonds with lower ratings carry a higher default risk, so they offer higher yields to attract investors despite the added danger.
What Is a Junk Bond?
Junk bonds are non-investment grade, high-yield bonds considered high-risk, with ratings from BB+ to D or unrated. They can provide profits but come with liquidity issues and higher loss potential.
What Is an Investment Grade Bond?
An investment grade bond is a high-quality, low-risk option with low default rates, rated AAA to BBB.
The Bottom Line
In summary, a bond rating grades a bond's creditworthiness based on the issuer's financial strength, assigned by agencies like Moody’s, S&P, and Fitch.
Grades like AAA signal low risk and yields, while lower ones like B- indicate higher risk and returns. As a long-term investor, focus on investment grade for reliability; if you're into high-risk plays, consider junk bonds.
Key Takeaways
- Bond ratings serve as scores to evaluate a bond's quality and creditworthiness.
- Investment grade bonds get AAA to BBB- from S&P and Fitch, or Aaa to Baa3 from Moody’s; junk bonds have lower ratings.
- Higher ratings mean lower interest rates due to reduced risk.
- Agencies rate various bonds, from corporate to sovereign.
Other articles for you
Capital employed measures the total capital a company invests to generate profits and evaluates its efficiency.
Sampling error is the deviation between a sample's value and the true population value due to the sample not perfectly representing the population.
Non-assessable stock protects shareholders from additional financial demands by the issuing company beyond the initial purchase price.
Total return measures an investment's complete performance by including all income and gains over a period.
A hammer clause in insurance policies allows insurers to force policyholders to settle claims by capping indemnification and shifting defense costs.
A stock market crash involves a sudden, sharp drop in stock prices often triggered by events or panic, leading to economic repercussions, with measures like circuit breakers in place to mitigate them.
Level 1 assets are highly liquid financial instruments with transparent, reliable market-based valuations, making them the easiest to value compared to Levels 2 and 3.
Kondratieff Waves are long-term economic cycles in capitalist economies driven by technological innovations, lasting 40 to 60 years.
Turnkey asset management programs (TAMPs) are fee-based platforms that help financial advisors outsource investment management to focus on client service and business growth.
The half-year convention treats assets acquired during the year as purchased mid-year, allowing only half depreciation in the first and last years to better match expenses with revenues.