Evaluating investment quality is an important part of any investment decision. However, with some investments, quality may be difficult to judge.
For example, if you're considering a bond that has been issued to finance a project hundreds of miles away, you probably won't be able to drive by the site to evaluate the project. You also might not have the time or expertise to investigate the issuer's financial stability. You can read the offering documents and financial statements but may still be unable to make a professional judgment.
That's where bond ratings can help. In 1909, John Moody originated a system of rating securities to provide investors with a relatively simple way to evaluate investment quality. Today, two investment rating services are primarily used in the securities industry: Moody's and Standard & Poor's. They are similar in the way they classify bonds, and they are the most used and respected rating services available.
To help you understand bond ratings, let's look at the Moody's system. Moody uses nine major symbols to rate bonds. From highest to lowest in investment quality, they are Aaa, Aa, A, Baa, Ba, B, Caa, Ca and C. The lower the rating, the lower the investment quality. The Standard & Poor's ratings are similar. From highest to lowest in investment quality, they are AAA, AA, A, BBB, BB, B, CCC, CC, C and D.
Some bonds may be non-rated (NR). In some cases, this indicates low investment quality. In other cases, bonds may be non-rated for reasons unrelated to quality. For example, because issuers of tax-free and corporate bonds must apply for a rating and pay a fee, they may decide simply to not apply. A bond may also be non-rated if the issue is very small, if there is a lack of essential data relating to the issuer or if the issue is privately placed with institutional investors.
In addition, ratings are not permanent. Many bonds are long-term, and circumstances affecting their ratings may change over time. Issuers of previously rated bonds are periodically reviewed by the rating services. If their financial condition changes, so may the bond rating. The current rating reflects the best judgment of investment quality at the current time.
Therefore, when purchasing tax-free or corporate bonds, it is vital to monitor ratings regularly to be aware of any changes in investment quality.
About the Author
For twenty years Adam Starchild
has been writing books about
these subjects, and they are published by a variety of publishers. They are
available in many bookstores or public libraries.
For more information on asset protection, see
Asset Protection & Becoming Judgment Proof.
Copyright © 1995 by Adam Starchild
The Investor's Library has reprinted this copyrighted article with the permission of the author.