What it is:
Ratings Service is provided by companies that evaluate the risks associated with debt securities.
How it works (Example):
Companies, such as Moody's, Standard & Poor's (S&P), and Fitch, provide ratings for securities based on underwriting criteria. The criteria include a number of factors, such as the underlying security, method of repayment, revenue history, qualifications of the team, market factors, etc. Based on this review of the business plan and risks involved in the security, the ratings service issues a formal rating, usually from AAA to D.
For example, S&P uses the following rating system:
- AAA and AA -- High credit-quality
- AA and BBB -- Medium credit-quality
- BB, B, CCC, CC, C -- Low credit-quality, usually referred to as "junk bonds"
- D -- bonds in default for non-payment
Why it Matters:
Ratings service provides a valuable tool for investors to determine the quality and risk associated with an investment.