Investment Grade - Explained
What is Investment Grade?
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Table of ContentsWhat is Investment Grade?How is Investment Grade Used?
What is Investment Grade?
Investment grade is a quality designation for a security of financial instrument. The higher the credit rating, the lower the risk of default and vice versa. Default means a failure to pay or live up to the obligations of the instrument. The investment grade designation is given by a financial ranking body, such as Moodys and Standard & Poors.
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How is Investment Grade Used?
There are different ways of denoting a company's credit quality rating of a security. Take for example the Standard and Poor's rating system:
- AAA , AA+, AA, and AA- - are High credit quality
- A and BBB are medium credit quality
- BB, B, and CCC are low quality, known as junk debt.
The Moodys company make use of the following to denote their rating of credit quality rating of a security.
- Aaa, Aa1, Aa2, Aa3, A1, A2, A3 - High credit quality
- Baa1, Baa2 and Baa3 - Mid to Risky Credit quality.
This system signals the risk that may be associated with holding the security. As such, it affects the expected rate of return for investors have when purchasing the security. A high-risk security must deliver a higher rate of return than a lower-risk security. The actual amount returned will be a percentage of the value or purchase price of the security. Generally, the highest-rated securities are bonds. Bond provide a promised return. Holders have the status of credit. Creditors have higher priority to payment (particularly in the event of bankruptcy or liquidation of the issuing entity) than shareholders. Shares of stock are generally a higher-risk instrument; but, their risk level varies considerably based upon the company. Derivative instruments vary wildly in their credit rating, and history shows that it is difficult to rate their risk levels appropriately.