Introduction
This assignment briefly discusses the meaning and importance of credit rating. It also covers the factors that can cause a change in the credit rating of a company.
“A” Rating and “C” Rating
The analysts give a rating to various bonds issued by a company in the capital market. An “A” rating of the bond indicates that the company is well-established to pay its obligations. The credit rating of “A” means that an investor can have confidence that this bond is secured in the capital market. The analysts give a rating by focusing on different factors such as volatility in stock prices, financial health, profitability trend, market value, and plans of a company. Therefore, it can be said that a credit rating is the outcome of a detailed analysis of a company that indicates its worth (Pascalis, 2017). An investor considers this rating important for investors when deciding to purchase bonds or not.
A credit rating is known as the assessment of risks involved in purchasing or dealing with securities. The main reason for the evaluation of this credit risk is to determine whether a specific company is eligible to pay its debt or not. The credit rating of “C” of a bond clarifies that it is a speculative grade and should be avoided to reduce the chance of a loss of investment. This rating indicates that the company has filed a bankruptcy petition and may end its operations in the coming months. The financial deficit requires debt financing in this case. Therefore, analysts issue “C” rating to show that this investment should be avoided.
Factors Causing a Change in Credit Rating
Credit rating refers to the evaluation of the creditworthiness of a company. A credit score is prepared and maintained to ensure control over liabilities. There are specific factors listed below that directly affect the credit rating of a company.
- Late payment to suppliers after the agreed timeline.
- Payment of short-term debts after their maturity.
- Delay in payment for utilities.
- Late long-term loan repayment.
- We are obtaining new loans to repay previous loans.
- Late payment surcharge on delayed loan payments.
All the above-listed factors negatively affect the credit score of a company, which reduces its credit rating. Although there are external pressures on companies, including unfavorable market conditions, their credit rating is mainly based on the internal assessment of their ability to settle loan obligations (Darbellay, 2013).
Relationship between Credit Rating and Merit of an Investment
There is a direct relationship between the credit rating of a company and the ‘merit of an investment in its bonds. Both ‘credit rating’ and ‘merit of investment are used for assessing the credit risk of a security. The ‘merit of an investment’ relates to determining the loss-causing characteristics of an investment. However, the credit rating of a company is also used for assessing the possibility of loss by determining its ability to pay both short-term and long-term liabilities.
The elements of credit score also relate to the merit rating of a corporate bond (Herold, 2017). Therefore, it can be said that merit rating is important for evaluating the overall credit risk of the company issuing a bond. A bond’s maturity value has a direct link with its merit rating. Therefore, it is understood that merit rating has a high impact on the credit rating of a bond.
References
Darbellay, A. (2013). Regulating credit rating agencies. London, UK: Edward Elgar Publishing.
Herold, T. (2017). Financial terms dictionary: The 100 most popular terms explained. New York, NY: Thomas Herold.
Pascalis, F. D. (2017). Credit ratings and market over-reliance: An international legal analysis. New York, NY: BRILL.