Question

Highlight the significance of credit rating in investment decision? Discuss all credit rating scales.

Answer 1

Often we come across news articles stating the upgradde or downgrade of credit rating of various organizations by the well known credit rating agencies like Moodys, ICRA, CRISIL, Standards & Poor etc. These ratings are analysis of the credit riska associated with the financial instruments or a financial entity. They are awarded by credit rating agencies after comprehensive analysis of the debt servicing ability, quality of the management, business and financial risks.

The credit rating highlights the ability to pay back the debt, Good credit rating depicts good ability and decline in the rating depicts decline in the ability to pay.

Significance of a good credit rating in investment decision

1. A highly rated instrument lowers the cost of borrowing for the company.
2. It opens up the access towards lending from many lenders.
3. It is a good marketing tool for the company

Decline in the rating hampers the company`s ability to borrow any more debt.

The majorly used credit rating scales are :

Long term scales-

AAA- Highest degree of safety- lowest credit risk

AA- High degree of safety, low credit risk like AAA

A- Adequate degree of safety

BBB: Moderate degree of safety

BB: Moderate risk

B: High risk

C: Very high risk

D: extremely likely to default soon

Short term scales

A1: Highet degree of safety, lowest credit risk

A2: High degree of safety, low credit risk

A3: Good degree of safety, riskier than A1 & A2

A4: Minimal degree of safety, Very high credit risk , susceptible to default

D; expected to default soon

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