Takeaways
- Moody's credit ratings fall into either investment or non-investment grade.
- "Aaa" bonds are investment-grade bonds that have the highest quality issuances.
- Junk bonds have non-investment grade ratings and are high-risk and reward.
- Moody's, Standard and Poor's, and Fitches are the leading credit rating agencies.
- Fixed-income investors use Moody's credit rating to assess investment risk across industries, geographic regions, sectors, and issuance types.
What Is Moody’s?
Moody's is a global credit rating agency that provides creditworthiness and financial stability evaluations of businesses, debt issuances, and financial securities. As one of the world's leading credit rating agencies, Moody's plays a critical role in domestic and international financial markets.
Moody's credit ratings are not simple individual credit scores offered to potential lenders. Instead, Moody's provides bond issuance credit ratings, research, and risk analysis for corporations, financial institutions, and governments.
As one of the top credit agencies, it creates creditworthiness evaluations for bond issuers and assigns ratings based on the issuer's projected ability to meet their financial obligations. These credit ratings are essential for hedge funds, pension funds, endowment funds, and other institutional investors to assess bond risk.
Investors need to determine a bond's relative risk level when comparing its attractiveness relative to other investment opportunities, such as bonds, stocks, CDs, or REITs. Moody's is not the only credit rating agency institutional and retail investors turn to; it competes with other credit rating firms, like Standard & Poor's and Fitch Ratings.
These three credit rating agencies can tremendously affect the entire bond investing landscape. The ratings they assign to new or existing debt drive daily investment decisions and impact the interest rates corporations, financial institutions, and governments must pay on their debt securities. Investors use Moody's credit ratings as a barometer for a bond's risk assessment.
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How Moody’s Works
Moody's performs an in depth financial analysis into the health and stability of companies, governments, and financial institutions that issue debt securities. The firm's primary function is to assess the relative risk associated with bonds and their issuers.
The debt evaluation process is a detailed and propriety analysis that involves analyzing the issuer's idiosyncratic risks, such as revenue performance, profit consistency, free cash flow, and current debt levels. Moody's also evaluates industry-level risks, the geopolitical economic environment, and prevailing macroeconomic conditions.
With all this information, Moody's then assigns a credit rating score. This score acts as an at-a-glance estimate of the issuer's creditworthiness and the corresponding likelihood that they will repay their debt obligations on time and in full.
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Just like individual credit scores in the consumer market, a higher credit rating indicates a lower investment risk. Conversely, a low rating suggests a higher credit risk, or the risk of default.
Bond ratings are extremely valuable to investors because they help guide risk-based investment decisions worldwide. Moody's is considered independent and highly objective, so the insights and ratings it provides are well-respected across economic sectors and industries.
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Moody’s Rating System
Moody's credit rating system is created to convey an issuer's potential credit risk and creditworthiness quickly. Ratings are split into two main categories: investment and non-investment grade. Take a look at the differences:
Investment Grade
Investment-grade bonds will have ratings of "Aaa" to "Baa," with Aaa being the highest possible rating that can be obtained, representing the highest quality of obligations and containing the lowest level of credit risk. Moody’s defines credit risk as the risk that an entity may not meet its contractual financial obligations as they come due and any estimated financial loss in the event of default or impairment.[1]
Bonds in the investment-grade category frequently offer lower yields and interest rates than non-investment-grade bonds (more below) because conservative investors highly prize them. Investors who want to retire early, create passive income, or are new to investing prefer investment-grade bonds because they want to build an income stream while minimizing their investment risk.
| Moody’s Ratings | Description |
|---|---|
| Aaa | Highest quality and lowest level of credit risk |
| Aa | High quality and very low credit risk |
| A | Upper-medium grade and low credit risk |
| Baa | Moderate credit risk and has certain speculative characteristics |
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Non-Investment Grade
Non-investment-grade bonds are much lower quality than investment-grade bonds and are rated from "Ba" down to the lowest rated "C ."They are considered speculative investments and are often referred to as junk bonds. These bonds pay higher interest rates to bondholders.
Bonds in these credit rating brackets face serious financial headwinds and inherently have much more risk. However, some investors like that risk because it comes with the opportunity to earn higher returns. These bonds are issued by entities facing severe financial difficulties and might already be in or near default.
| Moody’s Ratings | Description |
|---|---|
| Ba | Speculative and are subject to substantial credit risk |
| B | Speculative and are subject to high credit risk |
| Caa | Speculative and are subject to very high credit risk |
| Ca | Highly speculative and in or very near, default |
| C | Lowest rated and typically in default |
(Source: Moody’s Website)
History of Moody’s
Moody's was founded in the early 1900s by John Moody, who initially created the concept of rating bonds to better position investors with an independent risk assessment. His work originally began with railroad bonds, which, at the time, were the main source of infrastructure financing.
The firm's early success led the founders to expand their rating services to include the booming corporate landscape. From there, they went on to assess government debts.
Throughout most of the 20th century, Moody's diversified its operations and grew, eventually becoming one of the leading players in the global financial system. It was essential to provide transparency during the significant financial events that helped shape the U.S., such as the Great Depression, the 2008 Financial Crisis, and countless other economic crises.
Moody’s Corporation is now a publicly traded company listed on the NYSE and still provides credit ratings and research into risk management.
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Smart Summary
Moody's provides credit ratings to corporate, government, and financial institution's debt issuances and securities. It is mainly known for its easy-to-read credit rating system, which provides a forward-looking assessment of an entity's ability to meet its debt obligations. Moody's is one of the world's top three credit rating agencies, along with Standard and Poor's and Fitches. Fixed-income investors rely on Moody's credit ratings daily to assess and manage risk.
(1) Moody’s. Rating Symbols and Definitions. Last Accessed January 12, 2025.
