Understanding credit ratings

understanding credit ratings

A credit rating is an evaluation of the credit risk of a prospective debtor (an individual, a business, company or a government), predicting their ability to pay back the debt, and an implicit forecast of the likelihood of the debtor defaulting.

The credit rating represents an evaluation of a credit rating agency of the qualitative and quantitative information for the prospective debtor, including information provided by the prospective debtor and other non-public information obtained by the credit rating agency’s analysts.

A sovereign credit rating is the credit rating of a sovereign entity, such as a national government. The sovereign credit rating indicates the risk level of the investing environment of a country and is used by investors when looking to invest in particular jurisdictions, and also takes into account political risk.

Political risk is a type of risk faced by investors, corporations, and governments that political decisions, events, or conditions will significantly affect the profitability of a business actor or the expected value of a given economic action. Political risk can be understood and managed with reasoned foresight and investment.

Country Risk is often defined as the risk that country-specific factors could adversely affect an insurer’s ability to meet its financial obligations

Ratings are further broken down into components including political risk, economic risk. Euromoney’s bi-annual country risk index monitors the political and economic stability of 185 sovereign countries.Results focus foremost on economics, specifically sovereign default risk or payment default risk for exporters (also known as a trade credit risk).

The Big Three credit rating agencies are Standard & Poor’s (S&P), Moody’s, and Fitch Group. S&P and Moody’s are based in the US, while Fitch is dual-headquartered in New York City and London, and is controlled by Hearst.

The different agencies have different rating scales as well as evaluation methods used to atribute their ratings.

A rating expresses the likelihood that the rated party will go into default within a given time-horizon: 1 year (short-term) or above (long-term). In the past institutional investors preferred to consider long-term ratings. Nowadays, short-term ratings are commonly used.

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