You will be able to read a credit rating and explain what it does and does not tell you.
Kelvin looks up the company bond his relationship manager offered. Its factsheet says nothing about a credit rating. A friend's bond from a different company is rated BBB by one agency, and the friend says that means it is safe. Another friend says ratings are useless because the agencies rated some bonds highly just before they failed. Both friends are partly right. A rating is a useful opinion from people who study borrowers for a living. It is also late, narrow and sometimes missing.
Three agencies rate most of the world's large bond issuers: S&P Global Ratings, Moody's and Fitch Ratings. Each one studies a borrower's finances, business and debts, and gives it a grade. They can rate a company as a whole, and they can rate a particular bond, which may get a lower grade than the company if it ranks further back in the queue you met in lesson 6.1, What happens when a borrower cannot pay.
The grades run in letters from strongest to weakest. S&P and Fitch use AAA at the top, then AA, A, BBB, BB, B, CCC and lower, with plus and minus signs to show steps within each band. Moody's uses its own style, Aaa, Aa, A, Baa, Ba, B, Caa and lower, with the numbers 1, 2 and 3 for the steps.
The line that matters most falls in the middle. Investment grade means BBB minus or above at S&P and Fitch, or Baa3 or above at Moody's. Below that line, bonds are called high yield, or sub-investment grade, and they pay more because the agencies judge default to be noticeably more likely. Many funds can only hold investment grade bonds, so a downgrade across that line can force selling and push the price down sharply.
A rating is an opinion about the chance that the borrower fails to pay in full and on time. It is not a forecast of the bond's price.
That distinction matters because, as module 2 showed, a bond's price also moves with interest rates. A AAA government bond with a long maturity can lose a lot of value when yields rise, while its rating stays exactly where it was. The rating only speaks to credit risk. Duration speaks to interest rate risk. You need both.
A rating is also a ranking more than a precise figure. Lower grades have historically defaulted more often than higher ones over long periods, which is why the agencies publish default studies. But a single company's grade does not tell you the exact chance that it, specifically, will fail.
Agencies review ratings on their own schedules, and they tend to move gradually. Markets move every day. So by the time a downgrade is announced, the bond's price has often already fallen, because investors acted on the same bad news first.
That means a rating is better at telling you where a borrower stands in general than at warning you of trouble ahead. If a company's bond price has dropped and its yield has jumped while its rating stays unchanged, the market is telling you something the rating has not yet caught up with. Treat the price as the earlier signal.
There is a structural point to keep in mind too. Issuers usually pay the agencies to be rated. The agencies have rules to manage that conflict, but it is one reason to treat a rating as one input rather than the answer.
Here is the situation Kelvin found. Many Singapore dollar bonds sold to retail investors have no rating from any of the three agencies. The issuer may simply have chosen not to pay for one. That is legal and common. It is not proof that the company is weak.
It does mean the work falls to you. Without a rating, you judge the issuer yourself, from what it publishes. Lesson 6.4, Run a credit checklist on one bond, gives you a short list for doing that: what the company does and how it earns the cash to pay, where the bond ranks, what its call and deferral terms say, and how its yield compares with a government bond of a similar term.
A missing rating should also make you more careful about how much you put in. With no outside opinion, a single bond deserves a smaller slice of your money, not a larger one because its coupon looks generous.
When a bond does have a rating, three questions get the most out of it. Who gave it, since one agency may rate a borrower differently from another? Is it a rating of the company or of this particular bond? And when was it last changed, and in which direction? A rating that was cut twice in a year tells a different story from one that has not moved in a decade.
Kelvin went back to his own bond and his friend's with those questions. Do the same for one bond you could buy: find out whether it is rated, by whom and when the rating last moved, and if it has none, write down what you would check instead.
Look up whether one bond you can buy has a rating, from whom and when it was last changed, and note what you would check if it has none.
Junxiong-WFG Organisation is an authorised representative of AIA Financial Advisers Private Limited (Reg. No. 201715016G).