Bond ratings
Also known as: credit ratings, bond credit ratings
Bond ratings are letter grades assigned by credit rating agencies that measure a bond issuer's ability to make interest and principal payments on time. They classify bonds by default risk, from the highest investment grade down to speculative junk status.
Bond ratings are opinions on credit risk — the likelihood that an issuer will fail to pay interest or repay principal. The three dominant agencies are Moody's, Standard & Poor's, and Fitch. S&P and Fitch use a scale running AAA, AA, A, BBB, BB, B, CCC, CC, C, D, while Moody's uses Aaa, Aa, A, Baa, Ba, B, Caa, Ca, C. Ratings measure credit quality only; they say nothing about interest rate risk, liquidity, or whether a bond is priced fairly.
The most important dividing line falls between BBB/Baa and BB/Ba. Bonds rated BBB/Baa or higher are investment grade; anything below is speculative, commonly called high-yield or junk. That distinction has practical consequences: many institutional investors, pension funds, and insurance companies are restricted to investment-grade holdings, so a downgrade across the line can force selling and push prices down sharply.
Rating and yield move in opposite directions. A lower-rated issuer must offer a higher yield to compensate investors for taking on more default risk, which is why a junk bond pays far more than a comparable Treasury. Ratings are not static — agencies upgrade, downgrade, and place issuers on watch as financial condition changes.
Suitability questions built on bond ratings appear throughout the securities exams. The Series 6, Series 65, and Series 66 all expect you to match a bond's rating to an appropriate investor profile — investment grade for conservative income needs, high yield only for clients who can absorb the risk — and to recall where the investment-grade cutoff sits on both the S&P and Moody's scales.
Key takeaways
- Bond ratings grade an issuer's credit risk, not the bond's price, liquidity, or interest rate risk.
- BBB/Baa and above is investment grade; BB/Ba and below is speculative, or junk.
- Lower ratings require higher yields, since investors demand compensation for greater default risk.
- Many institutions are limited to investment-grade bonds, so a downgrade below the line can trigger forced selling.