Glossary
Credit Rating
Credit ratingrating agencies.
Features:
• It reflects only an opinion on the relative creditworthiness of an issuer or the credit quality of a debt obligation. It is not a measure of the asset value and does not indicate the reasonableness of any investment;
• It is assigned not only to issuers of liabilities or securities (sovereign states, local authorities, special-purpose entities, profit-making and non-profit organizations), but to securities as well (bonds, deposit and saving certificates, commercial securities, preferred shares and structured finance instruments);
• To designate the rating, an alphabetic scale is used, usually from AAA to D, where AAA is the highest rating and D is the lowest rating that is indicative of the borrower’s insolvency: default;
• Ratings are usually divided into investment (from AAA to BBB-) and non-investment, or junk ratings (below BBB-).
Advantages:
• Simplification of the process of issuing and placing bonds and other debt obligations should a credit rating be available as an effective and generally accepted relative measure of credit risk;
• For an investor, the rating helps to make investment decisions, making it possible to compare the credit risk level of issuers or securities with their own permissible level of risk, as well as to compare issuers and securities with each other in terms of this indicator;
• For an institutional investor, the rating is an addition to the performed credit analysis of financial instruments, as well as a reference point for establishing credit risk thresholds and stating investment rules;
• For financial intermediaries, the rating allows for the establishment of the initial price for a structured investment vehicle and determining the level of interest that can be requested thereon in;
• It facilitates for the issuer the attraction of debt financing on beneficial terms: the higher the rating is, the lower is the interest rate on debt obligations; it helps to determine the level of interest on new issues of debt obligations; high ratings supports the attraction of new investors;
• For companies and financial institutions, the rating is used to assess the counterparty risk.
Disadvantages:
• Availability of an international scale and a national scale that does not take into account the insolvency risks of a particular country;
• Lagging behind in comparison with the market;
• Possibility of infliction of financial losses due to a doubtful downgrade of the borrower’s rating and, as a result, an increase in interest on the company’s debt obligations;
• Discontinuity of rating scores generates growth of market volatility. This effect is especially significant when the rating is downgraded from investment grade to junk.
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