Credit rating

Page written by AI. Reviewed internally on April 12, 2024.

Definition

A credit rating is an evaluation of the creditworthiness of an individual, company, or government entity.

What is credit rating?

It is a key evaluation performed by credit rating agencies to provide investors, creditors, and the general public with an indication of the likelihood that the borrower will fulfil their financial obligations

Credit rating agencies typically use letter grades or symbols to represent credit ratings. The scale may vary slightly between agencies, but generally, higher grades indicate a lower credit risk, while lower grades suggest a higher risk of default.

Credit rating agencies consider various factors when assigning ratings. These factors may include financial metrics, industry conditions, economic trends, management quality, and geopolitical factors. The goal is to provide a comprehensive assessment of the organisation’s ability to meet its financial obligations.

Credit ratings are not static; they can be periodically reviewed and revised based on changes in the financial health and risk profile of the entity being rated. Upgrades or downgrades in credit ratings can have significant implications for borrowing costs and market perception.

Example of credit rating

XYZ Corporation is seeking to issue bonds to raise capital for a new project. Before investors decide to purchase these bonds, they look at the credit rating assigned by a credit rating agency, such as Moody’s.

XYZ Corporation receives the following credit rating:

Moody’s: A3

This rating of A3 indicates that Moody’s considers XYZ Corporation’s bonds to be of relatively high quality and low credit risk. Investors may interpret this rating as a positive sign, suggesting that the likelihood of XYZ Corporation defaulting on its bond payments is low.

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