Bond Rating

Bond ratings: definition and why they matter

A bond rating is a letter-grade assessment of a bond issuer’s ability to meet interest and principal payments on time. Ratings—issued by independent agencies—summarize credit risk and directly influence borrowing costs, market demand, and bond prices. Higher-rated bonds are seen as safer and typically carry lower yields; lower-rated bonds carry higher yields to compensate investors for greater default risk.

Who issues ratings and how they’re determined

Major rating agencies:
* S&P Global Ratings
* Moody’s Investors Service
* Fitch Ratings

Analysts at these agencies evaluate an issuer’s financial strength and likelihood of default by examining factors such as:
* cash flow and profitability
* debt levels and maturity schedules
* liquidity and access to capital markets
* economic, industry, and country risks
* governance and fiscal policy (for sovereigns)

Each agency applies its own methodology and outlooks (stable, positive, negative) to assign a final rating.

Rating scales and investment categories

Common rating ranges:

S&P and Fitch
* Investment grade: AAA down to BBB-
* Non-investment grade (high-yield/junk): BB+ down to D

Moody’s
* Investment grade: Aaa down to Baa3
* Non-investment grade (high-yield/junk): Ba1 down to C

“Not rated” may be applied when an issuer hasn’t been evaluated.

Investment-grade bonds are considered lower risk and are preferred by conservative, income-focused investors. Junk bonds offer higher yields but greater risk of default and potential liquidity issues, attracting speculative investors or those seeking higher income.

How ratings affect pricing, yield, and borrowing costs

• A higher rating lowers an issuer’s cost of borrowing because investors accept lower yields for reduced default risk.
• A lower rating raises required yields, reducing bond prices and increasing the issuer’s financing costs.
• Ratings also shape investor demand and the pool of eligible buyers—many institutional investors and funds restrict holdings to investment-grade securities.

Notable examples and historical lessons

• 2008 financial crisis: Rating agencies were criticized for overly optimistic ratings on mortgage-backed securities. For example, many MBS that had large AAA allocations were later downgraded, undermining investor confidence and amplifying losses.
• U.S. sovereign ratings: In recent years, agencies have reassessed U.S. sovereign credit on fiscal and governance grounds—Fitch downgraded U.S. long-term ratings to AA+ in 2023, and Moody’s downgraded to Aa1 in 2025—citing rising debt burdens and fiscal challenges. Sovereign-rating actions illustrate that ratings reflect long-term fiscal outlooks as well as current strength.

Practical guidance

• Long-term, conservative investors typically favor investment-grade bonds for capital preservation and stable income.
• Investors seeking higher yields can consider high-yield (junk) bonds but should be prepared for higher default and liquidity risk.
• Use ratings as one input among many: analyze issuer financials, bond covenants, market conditions, and diversification needs.
• Be aware of potential conflicts of interest in the issuer-paid rating model and supplement ratings with independent due diligence.

Key takeaways

• Bond ratings summarize creditworthiness and help price default risk.
• Major agencies—S&P, Moody’s, and Fitch—use distinct scales but similar concepts (investment grade vs. high-yield).
• Higher ratings generally mean lower yields and lower borrowing costs; lower ratings mean higher yields and higher risk.
• Ratings are influential but not infallible—combine them with fundamental analysis and portfolio diversification.