AAA rating

From CUP resources:

What is it?

AAA is the top bond credit rating awarded by independent rating agencies such as Standard & Poor’s (S&P), Fitch and Moody’s, to assess the creditworthiness of a corporation’s debt issues. In simple terms, a corporation with a good rating, such as AAA, is considered extremely safe for lenders to invest their money in. Lenders are reassured by such ratings that a borrower will be "good for the money" and will not default on the debt. When a rating agency downgrades a corporation’s rating, it can trigger severe problems for the corporation (e.g. lenders may demand repayment or higher interest rates, it may be harder and more expensive to borrow money from other lenders, share prices may fall, etc.), which can lead to further downgrades. This type of chain reaction has played an important part in the current financial crisis.

Why is it in the news?

Countries also issue bonds to borrow money, so they too have credit ratings. S&P has recently revised its outlook of the UK’s credit risk from stable to negative, and warned its rating may be downgraded from AAA to AA. This is still extremely high (the lowest rating is D: see Wikipedia article below), but the downgrade is likely to damage confidence. There is also speculation that the US government may also lose its AAA rating, as a result of the huge amounts of money it has used to bail out banks and stimulate the economy.

Discussion:

• How do you think credit ratings are calculated?
• What are the dangers of relying on credit ratings? (e.g. A corporation with a good rating may be able to borrow much more heavily than others, so may actually be more vulnerable to major economic changes. The problems with AIG stemmed partly from overconfidence in its AAA rating).
• Think of some countries you know well. What do you think are their credit ratings? (NB See Standard and Poor's website for a complete list).
• Given that rating agencies have so much power to boost or damage a corporation or country, is it right that it is left to independent companies?

Where can I read more about it?

• Bond credit rating, Wikipedia.