Thursday, September 17, 2009

What are Credit Ratings?

Corporate and municipal debt securities sold in the financial markets today generally must carry a credit rating assigned by one or more rating agencies. the two widely respected credit-rating agencies in the U.S. are Moody‘s Investor Service and Standard and Poor‘s Corporation, both headquartered in New York City. The ratings assigned by these private companies are generally regarded in the investment community as an objective evaluation of the probability that a borrower will default on a given security issue.
Default occurs whenever a security issuer is late in making one or more payments that it is legally obligated to make. In the case of a bond, when any interest or principal payment falls due and is not made on time, the bond is legally in default. While many defaulted bonds ultimately resume the payment of principal and interest, others never do, and the issuing company winds up in bankruptcy proceedings. In most instances, holders of bonds issued by a bankrupt company receive only pennies on each dollar invested, once the company‘s assets are sold at auction. Thus, the investor who holds title to bankrupt bonds typically loses both principal and interest. It is no wonder, then, that security ratings are so closely followed by investors. in fact, many investors accept the ratings assigned by credit agencies as a substitute for their own investigation of a security‘s investment quality.

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