What Are Bond Ratings?

• Bond ratings are created by financial institutions like Moody's and Standard & Poor's. These companies research the financial strength of each bond issuer and then issue a rating based on this information. The rating tells you how likely the company is to default on the debt at some point in the future. Bonds that are rated highly are considered to be the strongest companies financially. Those with poor ratings are considered to be on the verge of filing for bankruptcy.
  
  

Bond Rating System

• The bond rating system is different for every company that issues ratings. While most of these financial agencies use a similar system, they each have a few features that are unlike the other systems. For example, with the Standard and Poor's system and the Moody's system, the best companies get ratings of "AAA." As the quality of the company decreases, the rating decreases. For instance, it goes all the way down to "C."
  
  

Using Bond Ratings

• Regular investors and large institutions use bond ratings when making investment decisions for bonds. When you use a bond rating, you have to look at it as merely an opinion instead of a fact. Just because a company has a "AAA" rating, that does not necessarily mean that the company could never go bankrupt. This just means that the statistical probabilities point to a company that will be in business for the long-term. You have to look at all of the factors involved with a company and not just the bond rating.
  
  

Interest Rates

• In some cases, investors use bond ratings to identify opportunities to earn higher returns instead of only looking at which investments are the safest. When a company has a low bond rating, it has to offer a higher interest rate on the bonds that it issues. Otherwise, investors would not be willing to take on the risk that comes with investing in these bonds. If you want a higher return on your investment, you can invest in lower-rated bonds.