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What is Credit Rating? Meaning Explained Lucidly

square What is Credit Rating? Meaning

Credit rating is done for debt instruments such as debentures, fixed deposits, commercial papers, bonds, etc.

credit rating

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The company which issues debt instruments is called an issuer or issuing company. The issuer, issues instruments to collect finance from investors.

Investor looks at the credit rating of instrument and issuer before investing.

  1. If the credit rating is a high, investor will invest in the company. That is, he will purchase the debentures, bonds, etc. issued by that company.
  2. If the credit rating is low, investor will not purchase the debentures, bonds, etc. of that company.

So, credit rating guides the investor while investing.

Credit rating is an opinion about a debt instrument and its issuer. It tells an investor, whether the debt instrument is safe or risky. It tells whether the issuer will be able to pay the interest and repay the principal amount in time.

Credit rating is only an opinion. It is not a recommendation. It does not ask an investor to buy, hold or sell an instrument.

So, credit rating is an opinion about the future ability and legal obligation of the issuer to make timely payments of principal amount and interest on their debt instruments.

Credit rating is done by independent credit-rating agencies like:

  1. S & P, which is based in USA,
  2. while CRISIL, CARE and ICRA Ltd., which are based in India.

Credit rating is done by experts after examining various factors. The rating is expressed in alphabetical or alphanumeric symbols.

Following are examples of credit rating:

  1. If the rating of debenture is AAA (Triple A), then it is considered to have the highest safety for the investor.
  2. If the credit rating is DDD (Triple D),, then the debenture is considered to have highest risk for the investor.

The issuing company asks the credit-rating agency to rate its instrument. This is done before issuing the instrument. The agency collects and studies information about the issuing company. Then it rates the instrument.

Credit rating is not permanent, and it is reviewed periodically.

Read articles on benefits and demerits of credit rating.


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