Credit rating agencies, rating scales, and the key factors used to assess bond credit risk.
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- Name the three major credit rating agencies in the United States.
- Standard and Poor's (S&P), Moody's, and Fitch.
- What does S&P stand for?
- Standard and Poor's.
- Which rating agency uses Aaa instead of AAA for its highest rating?
- Moody's.
- What is the highest credit rating on the S&P scale?
- AAA (triple A).
- What does AAA rating mean?
- Lowest risk of default; extremely strong capacity to meet financial commitments.
- At what rating does a bond transition from investment-grade to speculative-grade (junk)?
- Below BBB (on S&P); below Baa (on Moody's).
- What is the lowest rating on the S&P bond scale?
- D, which means the bond is in default.
- What does the plus or minus modifier mean on an S&P rating?
- It indicates relative position within the rating category, with plus being stronger and minus being weaker.
- Which ratings does Moody's classify as investment-grade?
- Aaa, Aa, A, and Baa.
- What do speculative-grade ratings also go by?
- Junk ratings or high-yield ratings.
- Name three key factors credit agencies consider when rating a corporate bond.
- Industry conditions, issuer's competitive position, and financial metrics such as debt, liquidity, and profitability.
- What does interest coverage ratio measure?
- The ability to service debt, calculated as EBIT (earnings before interest and taxes) divided by interest expense.
- What is leverage in credit analysis?
- The amount of debt a company uses to finance its assets, typically measured as debt-to-equity or debt-to-assets ratio.
- Which is generally more favorable for credit quality: high or low leverage?
- Low leverage, because less debt means lower financial risk and more capacity to weather downturns.
- What does liquidity measure in credit analysis?
- A borrower's ability to meet short-term obligations and how easily assets can be converted to cash.