Question

List one strength and one weakness of credit ratings as a key ingredient in corporate credit risk measurement methods, with brief explanations.

Answer 1

Strength : Credit rating helps investors in saving their resources by providing them the information required at a lower cost.

Since the credit rating agencies rating methodology includes performing industry and business analysis , financial analysis which is usually a tedious task for investors to perform on their own and infact a costly exercise too.

Credit ratings thus relieves investors from having to perform such broad analysis on their own and bothering with the information about the fundamentals of a company, its actual strength, financial standing,management details etc. This indeed saves a lot of time and effort of investors and instills confidence in them to reply upon the credit the rating for taking investment decisions.

Weakness : Credit rating methodology involves rating a company based on the present and the past historic data of the company. Since the rating is based on historical data, it defeats the very furpose of risk indicativeness of rating because many changes take place in the economic environment, political situation which directly affect the working of a company.