21-08-2013, 03:29 PM
Credit rating agencies
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INTRODUCTION:
A credit rating is a measure used by creditors to determine how much they can trust a certain borrower, whether the borrower is an individual, a corporation, or a country. The credit rating is derived using past financial data or the borrower’s credit history. There are several factors that can affect the credit rating of an individual including:
The person’s ability to pay a loan – Reflected by the person’s salary and other assets
The amount of credit in existence – This is what credit limits are for. If the person is near his credit limit or has reached it is harder to get a loan. This also reflects whether the person is in the habit of going into debt
Credit history – Shows whether the person makes payments on time. This also reflects the persons spending and saving patterns.
DEFINATION:
The process of assigning a symbol with specific reference to the instrument being rated, that acts as an indicator of the Current opinion on relative capability on the issuer to service its debt obligation in a timely fashion, is known as credit rating.
According to the Moody’s, “A rating on the future ability and legal obligation of the issuer to make timely payments of Principal and interest on a specific fixed income security.
HISTORY OF CREDIT RATING:
The initial rating exercise was started by Henry Poor who published financial statistics of Railroad companies in 1860. In addition to his publishing business, John Moody (Moody’s Investors Services) started publishing ratings for railroad bonds from the year1909.
The rating activity got a boost post Great Depression of 1933 when US Government Controller of Currency directed the banks in USA to purchase bonds rated BBB/Baa and above and the rest came to be known as ‘junk’ bonds. At present in US markets all commercial bonds are invariably rated.The credit rating system originated in the USA in seventies.
CREDIT SCORE:
Credit score is a number which lenders use to assess the risk of extending credit to you. In other words, credit score is an estimate of the risk that a bank will take to lend you money. It is also a snapshot of your credit file at a certain point in time. Credit score is a mathematical formula which takes into account many different pieces of information and compares it with hundreds of thousands of other credit reports from the past, to create patterns, which identify statistical possibility of future credit risk.
CREDIT RATING AGENCY:
A credit ratings agency is a company that assigns credit ratings to institutions that issue debt obligations i.e. assets backed by receivables on loans, such as mortgage-backed securities. These institutions can be companies, cities, non-profit organizations, or national governments, and the securities they issue can be traded on a secondary market.
A credit rating measures credit worthiness, or the ability to pay back a loan. It affects the interest rate applied to loans - interest rates vary depending on the risk of the investment. A low-rated security has a high interest rate, in order to attract buyers to this high-risk investment. Conversely, a highly-rated security (carrying a AAA rating, like a municipal bond which is backed by stable government agencies) has a lower interest rate, because it is a low-risk investment. These low-risk bonds are available to a wide range of investors, whereas high-risk bonds cater to a narrow investing demographic.
need and importance of credit rating:
A wide range of industries take advantage of credit scores to improve fairness, effectiveness and efficiency. Financial companies use credit scores to predict the risk of delinquencies and losses, which enables them to better allocate costs. Insurance companies use specialized credit scores to make fairer underwriting decisions. Credit scores even provide benefits at the macroeconomic level by helping small enterprises attain the funds they need and by facilitating the securitization and sale of financial products in the secondary markets, substantially increasing the influx of capital into a country.
CONCLUSION:
Credit rating agencies use their judgment and experience in determining what public and private information should be considered in giving a rating to a particular company or government. The credit rating is used by individuals and entities that purchase the bonds issued by companies and governments to determine the likelihood that the government will pay its bond obligations.