Question

How do bond ratings and interest rate spreads on bonds differ? Which measure is considered by many investors to be a more comprehensive measure of risk? Why?

Answer 1

Ans:- Bond ratings are nothing but it defines the credit quality or creditworthiness of government-issued bonds or corporate-issued bonds. In other words bond ratings tells the investors how much the bond is capable enough to pay its principal amount and interest. Higher the bond rating higher its credibility.

Interest rate spreads is nothing but the difference in the interest rate when the company or bank pays to its bonds holder and the return it will get from a similar type of security. In other words, the interest rate spread of bonds tells various factors such as its volatility, liquidity risk, default risk etc because if the interest spread is higher risk will also be high and the ratings on the bonds will be low.

Therefore if Bond's rating is higher then its interest rate spread will be low because the bond is more credible also because the borrowing cost of that bond will be lower than bond having low ratings.

Usually, for investors, the standard deviation is considered to a more comprehensive measure of risk because it measures independently the risk associated with stocks or bonds. Standard deviation tells the deviation from the expected return with respect to the market return.