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Credit Rating

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A credit rating refers to the capability of companies to repay their debt obligations (i.e. creditworthiness) and to the riskiness of certain investment products (i.e. bonds, debt securities, etc.). Lenders look at a credit rating to evaluate the likelihood of default by the borrowing party (i.e. counterparty risk). Credit ratings are assigned by credit rating agencies. Prior to assigning a credit rating, credit rating agencies look at a party's borrowing and one time repayment history in combination with current assets and obligations. A credit rating provides the creditor with knowledge about the debtor which enables such creditor to better quantify how much to charge for a loan for example and determine which terms to include in the transaction to maximize repayment (i.e. collateral requirements). In the case of bonds, a credit rating will allow investors to determine how safe a particular investment instrument is and evaluate if the yield offered is reasonable in light of the risk taken. Moody's, Standard & Poor's, and Fitch are commercial credit rating agencies that assign long-term and short-term credit ratings to companies, bonds, and other investment products. Those credit rating agencies use letters to qualify credit rating and some intermediary ratings can include numbers (i.e. Moody's) or signs (i.e. S&P and Fitch). For example, Moody's uses a Aaa credit rating for its highest credit rating (i.e lowest credit risk) and C for its lowest credit rating (i.e. default has already occurred). S&P and Fitch, however, will use AAA for their best long term credit rating and D for their worst. Note that a credit rating lower than Baa for Moody's or BBB for S&P is considered non investment grade and speculative (i.e. junk). Unlike companies or investment instruments, individuals are assigned a credit score, not a credit rating.

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