How Moody's Rating Scale Works

Moody's homepage in 2011 commenting on the US financial crisis. — Moody’s homepage in 2011 commenting on the US financial crisis.

Moody’s rating scale could help investors assess the creditworthiness of companies, governments and financial institutions when researching investment strategies. Developed by Moody’s Investors Service, the scale aims to determine the likelihood that an entity will be required to meet its financial obligations, thereby guiding investors in making decisions about their portfolios. It provides a standardized method for assessing credit risk and offers insight into the safety of investments based on the financial health of the issuer.

If you are building a portfolio, a financial advisor can work with you to identify investment opportunities and determine the level of risk.

What is Moody’s and what is its rating?

Founded in 1909 by John Moody, the company began by providing financial analysis on railroad bonds and quickly gained a reputation for its thorough and reliable ratings. Today, Moody’s has become one of the leading authorities on creditworthiness for investors, governments and businesses. The service rates a wide range of financial products, including corporate bonds, government securities, municipal bonds and structured financial products.

Moody’s ranks entities and securities based on their probability of default. This information can help investors establish their risk profile. Moody’s ratings also influence entities’ borrowing costs, as higher ratings generally translate into lower interest rates.

Moody’s ratings help maintain transparency and stability in the global financial system by providing an independent assessment of credit risk. Moody’s long history and broad influence have made it a cornerstone of the economic and financial industries, trusted by top financial advisors around the world.

What is Moody’s Rating Scale?

Moody’s rating scales are divided into two main categories: investment grade and speculative grade.

Investment grade ratings range from Aaa, the highest possible rating, to Baa3. These ratings suggest that the rated entity or security has a relatively low risk of default and is generally considered stable. Entities rated Aaa are considered to have the strongest capacity to meet their financial obligations, while Baa3 represents the lowest rung on the investment grade scale.

Below Baa3 is the speculative, or junk, category, which indicates higher risk. These ratings range from Ba1 to C, with C suggesting that the entity is in default or close to default with little prospect of recovery. Speculative ratings mean that entities are more vulnerable to adverse economic conditions, making them riskier investments.

Each rating is supplemented with a modifier of 1, 2 or 3 to provide additional granularity. For example, a Baa1 rating is higher than Baa2 but lower than A3. This system helps investors differentiate between different levels of risk within a rating category.

Moody’s vs. S&P vs. Fitch

Investors study a company's credit rating. — Investors study a company’s credit rating.

Moody’s, S&P, and Fitch are the world’s three major credit rating agencies, each offering a distinct but broadly similar rating system for assessing creditworthiness. While all three agencies provide ratings ranging from investment grade to speculative and default grade, their scales and ratings differ slightly.

Moody’s ratings use a combination of letters and numbers, such as Aaa, Aa and A, with numeric modifiers (1, 2, 3) to indicate relative standing within each category. S&P and Fitch, on the other hand, use a simpler scale based on letters like AAA, AA and A, with modifiers like plus (+) and minus (-) to provide additional granularity.

The highest ratings assigned by the three agencies (Aaa for Moody’s and AAA for S&P and Fitch) indicate the highest credit quality with minimal risk. However, while Moody’s C rating indicates default or near default, S&P and Fitch differentiate further with a D rating, which explicitly indicates default. Fitch also has an RD rating to signify that an entity has defaulted on its payments but has not gone bankrupt or been liquidated.

Description	Moody’s	S&P	Fitch
High quality, minimal credit risk	Aaa	AAA	AAA
High quality, very low credit risk	Aa	AA	AA
Upper-middle category, low credit risk	A	A	A
Medium category, moderate credit risk	Bleating	BBB	BBB
Speculative and substantial credit risk	Well	BB	BB
Speculative, high credit risk	B	B	B
Poor quality, very high credit risk	Caa	CCC	CCC
Highly speculative, likely in default or close to default	California	CC	CC
Very close to default	C	C	C
Default	C	D	D

Despite these differences, the ratings of the three agencies are widely recognized and valued by investors, and provide important information about the risk level of various types of investments and entities. The choice between them often depends on regional preferences or the specific type of analysis an investor needs.

Conclusion

A couple reviews the performance of their investment portfolio.

Moody’s rating scale assesses the creditworthiness of entities such as corporations and governments, helping investors assess credit risk. While ratings provide useful information, they do not alone determine investment strategy. Investors should consult a financial advisor to understand how these ratings impact their long-term financial goals.

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