What do the AAA, A, etc ratings of corporate bonds mean?

Question

Is a lower rated bond more likely to lose value? I thought these were "fixed income" and were safe from losing initial investment. So what is the purpose of a rating?

Answer 1

Ratings rank the likelyhood of you getting a) your interest payments at each fixed period and your principal (face value of the bond) at maturity.  If you buy a AAA 5 year bond, you will have a much better chance of getting your money back vs a "C" rated bond.  Because of this, the interest you recieve on a AAA is lower that a C rating (less risk, less return)

Even on a AAA rated bond, the price will fluctuate due to changes in interest rates, supply/demand, etc.  But the reason they are called "fixed income"  investments is that the interest payment you recieve is set (called the coupon) , and guaranteed (usually every six months).  So if you buy a bond with a High (AAA) credit rating, you can count on receiving a "fixed" income from it until it matures.

All bonds have a maturity.  When the bonds mature you get your money back (AAA).  This does NOT mean you get your investment back.  you will get face value back.  If you pay a premium (more than face value). the difference is slowly paid to you over the life of the bond - this is called amortization.

Answer 2

The letter ratings rank the borrowers credit worthiness. AAA being the highest. It drecreases to AA, A, B, C. and D is usually the lowest grade.

The purpose is to provide third parties with an idea of default likelihood for any particular investment. The grades are set by rating services who are detached and independent.

Note that one can lose money on any corporate bond regardless of initial rating. Ratings may go up and down over the life of the loan.

Good Luck

Answer 3

The risk in a bond is that the bond defaults and you lose all of your or some of your principal, the other risk is that they don't make an interest payment . US Treasury bonds are the safest with an implied rating of AAA, which is the highest rating. Independant rating companies use different criteria to rate a bond. The lower the rating , the higher the bond issuer will have to make his interst. If a corporation goes bankrupt, you as a bond holder might not get back the money the loaned them which is called the principal. There are government bonds, mortgage backed bonds, corporate bonds and very high risk bonds called Junk Bonds. The risk is higher but so is the interest rate. In the 90:s I think, Donald Trump had some bonds on the Taj Mahal that was paying about 17 or 18 percent. These were rated as junk bonds and the fear was that he would default. He did not, and all the investors got that high percentage and thier principal back when the bonds matured.

Answer 4

They may be fixed income and also fixed redemption.The price can and will fluctuate depending on interest rates and rating. Furthermore is there a possibility of defaulting on interest payment or redemption?

A lower rating bond will have a higher yield (coupon /price/100) at the point when you buy it.