As their name suggests, credit rating agencies assign a rating or score to financial assets, companies and countries and establish whether there is a low risk of bankruptcy or default on payments.
To reach their conclusions, these agencies carry out stringent analyses of the accounts and balance sheets of countries, insurance companies, banks and all kinds of financial products.
'Investment grade' comprises four categories based on the risk of default and, as we have already mentioned AAA, is the highest credit rating. The credit rating agencies use the following systems to express their ratings:
The credit rating is a critical indicator for investors and credit rating agencies therefore have enormous economic influence around the globe.
As well as being crucial indicators, these ratings directly influence the risk premium. In other words, a poor credit rating will increase the risk premium and investors will demand a much higher return in exchange for taking that risk.
In addition to 'investment grade' which, as we have mentioned, comprises the credit ratings for low default risk, some bonds are classified as 'speculative grade', meaning that their credit rating is low and the risk therefore very high. These bonds are also known as 'high yield' or 'junk bonds', and refer to those with credit ratings below BBB from Standard & Poor's and Baa3 from Moody's.