lnc10 - Lecture Notes Companion 10 Bond Ratings A bond is...

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Lecture Notes Companion 10 Bond Ratings A bond is simply an IOU issued by a government or corporation. It creates a legal obligation of the borrower (the issuer of the bond) to make principal and interest payments according to an agreed schedule. Bond issuers, just like borrowers from banks, vary widely in their creditworthiness, i.e, in their likelihood of repaying their debt. Because there is such a large and liquid secondary market for bonds, and information about which firms or governments are likely to repay their debts is so valuable, it’s not surprising that there is an industry devoted to rating borrowers. Called the bond rating industry, it consists of a small number of firms, the two dominant ones being Standard & Poor’s (S&P, which also complies a well-known set of stock indexes) and Moody’s Investor Services. All the raters study the financial records of firms and governments and issue ratings which are closely followed by the investment community. (The raters charge the rated firms for their services, which leads to potential conflicts of interest, but that’s a story for another day.) Here are S&P’s ratings. The others are similar. AAA—firm’s ability to pay its debt is “extremely strong.” AA—firm’s ability to pay its debt is “very strong.” A—. . . “strong,” but more susceptible to adverse financial conditions BBB—adverse financial conditions may make it more difficult for the firm to pay its debt BB—able to pay currently, but the firm faces adverse conditions that might make it unable to pay its debt B—able to pay currently, but adverse conditions might make it unable to pay its debt
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lnc10 - Lecture Notes Companion 10 Bond Ratings A bond is...

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