What it is:
How it works (Example):
Bond rating agencies like Moody's and Standard & Poor's (S&P) provide a service to investors by grading fixed income securities based on current research. The rating system indicates the likelihood that the issuer will default either on interest or capital payments.
For S&P, the ratings vary from AAA (the most secure) to C.
For Moody's, the ratings go from Aaa to D which means the issuer is already in default.
Only bonds with a rating of BBB or better are considered "investment grade." BBB bonds are considered to be suitable for investment by institutions. Anything below the triple B rating is considered to be junk, or below investment grade. Bond ratings are periodically revised based on recent data.
Treasury Bonds are not rated because they are backed by the "full faith and credit" of the United States government. They are considered the safest of investments because the government has the power to levy taxes in order to pay its debts.
Why it Matters:
Credit ratings have huge influence on the price and demand for certain securities, particularly bonds: The lower the credit rating, the riskier the investment and the less the investment is worth. Therefore, lower-grade/higher-risk securities pay higher interest rates to attract buyers.