Default Risk and Bond Rating – Finance – What is the Definition – Financial Dictionary

Default Risk and Bond Rating – Finance – What is the Definition – Financial Dictionary

Although bonds normally promise a fixed flow of income, this does not mean that they are riskless investments. Although U.S. government bonds are treated as risk-free, this is not the case for corporate bonds. If a company goes bankrupt then the bondholders will not receive the payments that they have been promised and therefore there is some uncertainty surrounding future bond payments. This uncertainty is called default risk. The default risk is measured by Moody’s Investors Services, Standard & Poor’s Corporation, and Fitch Investors Service. All three of these entities provide financial information on firms as well as well as ratings on corporate and municipal bonds.

Investment Grade Bonds Bonds that are rated BBB or above by Standard & Poor’s, or Baa or above by Moody’s are called investment grade bonds.

Speculative Grade or Junk Bonds Bonds that are rated BB or lower by Standard and Poor’s, Ba or lower by Moody’s, or bonds that are unrated are considered junk bonds or speculative grade bonds.

Bond rating agencies use financial ratios to grade bonds. The key ratios used are show below as follows
Coverage ratios
Leverage ratio
Liquidity ratios
Profitability ratios
Cash flow-to-debt ratio
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