Question

What role do Moody’s, Standard & Poor’s, or Fitch’s bond ratings play in the pricing of a bond?

Answer 1

Moody's, Standard and Poor's and Fitch Ratings are some of the most internationally well-known bond-rating agencies. These organizations operate to provide investors with quantitative and qualitative descriptions of the available fixed income securities. Generally, a "AAA" high-grade rated bond offers more security and a lower profit potential (lower yield) than a "B-" rated speculative bond.

Ratings agencies research the financial health of each bond issuer (including issuers of municipal bonds) and assign ratings to the bonds being offered. Each agency has a similar hierarchy to help investors assess that bond's credit quality compared to other bonds. Bonds with a rating of BBB- (on the Standard & Poor's and Fitch scale) or Baa3 (on Moody's) or better are considered "investment-grade." Bonds with lower ratings are considered "speculative" and often referred to as "high-yield" or "junk" bonds.

Moody's, Standard & Poor's, and Fitch append their ratings with an indicator to show a bond's ranking within a category. Moody's uses a numerical indicator. For example, A1 is better than A2 (but still not as good as Aa). Standard & Poor's and Fitch use a plus or minus indicator. For example, A+ is better than A, and A is better than A-.

Remember that ratings aren't perfect and can't tell you whether or not your investment will go up or down in value. Before using ratings as one factor in your investment selection process, learn about the methodologies and criteria each ratings agency employs. You might find some methods more useful than others.