Investment Grade – Definition

Cite this article as:"Investment Grade – Definition," in The Business Professor, updated March 28, 2019, last accessed August 13, 2020, https://thebusinessprofessor.com/lesson/investment-grade-definition/.

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Investment Grade Definition

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 Moody’s and Standard & Poor’s.

A Little More on What is Investment Grade

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 Moody’s 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.

References for Investment Grade

Academic Research on Investment Grade

An empirical analysis of the dynamic relation between investmentgrade bonds and credit default swaps, Blanco, R., Brennan, S., & Marsh, I. W. (2005). An empirical analysis of the dynamic relation between investmentgrade bonds and credit default swaps. The journal of Finance, 60(5), 2255-2281. This research proves a theoretical balance of credit default swap (CDS) prices and also credit spreads derived by Duffie 1999, also bases were stated for parity relation as an equilibrium condition. This researched also derive tow forms for deviation from parity and short-lived deviation from parity for all companies owing to lead doe CDS prices.

Sovereign credit ratings and spreads in emerging markets: does investment grade matter?, Jaramillo, L., & Tejada, M. (2011). This academic journal researched into probing what is implied by macroeconomic fundamentals. Also this research was necessitated owing to the factor that Sovereign investment grade status is often associated with lower spreads in international markets.

An empirical analysis of the dynamic relationship between investment grade bonds and credit default swaps, Blanco, R., Brennan, S., & Marsh, I. W. (2004).  This report understudies an analysis of credit default swaps (CDS) behavior for a firm as a sample from this research a theoretical bases for found for equivalence of CDS prices and credit spreads. This report outlined that CDS market is the major meeting point for credit risk price discovery and also that CDS prices are much fairer when inculcated with specific variables of the frim in short-run.

Rating agency actions around the investmentgrade boundary, Johnson, R. (2004). The Journal of Fixed Income, 13(4), 25-37. This research reported that non-NRSRO defines its grade BBB– more narrowly than the NRSRO, this was deduced from the aftermath of research conducted with data gotten from nationally recognized statistical rating organizations (NRSROs) and also from non-recognized agency.it was also deduced that there are chances for NRSRO to down trod commencing from lowest investment grade which is the BBB even up to neighboring trades.

Timing the investment grade securities market: Evidence from high quality bond funds, Boney, V., Comer, G., & Kelly, L. (2009). Journal of Empirical Finance, 16(1), 55-69. Survey was carried out on the tendencies for bond fund managers down to shift assets among bonds, cash and also across bonds of verities of maturities orders so as to cover the discrepancies in their relative returns. The result shows that there is absolute addition of timing across bond maturity spectrum and also there is adverse prove of market timing ability between cash and investment grade securities.

The performance of investment grade corporate bond funds: evidence from the European market, Dietze, L. H., Entrop, O., & Wilkens, M. (2009). The European Journal of Finance, 15(2), 191-209. This paper probe into risk-adjusted performance of mutual funds that is used in Germany is solely invest in “rather new” capital market section of the euro-dominated investment grade corporate bonds. This research proffer evidence for specific risk and return characteristics of investment grade corporate bonds with the use of rating-based indices and that of maturity-based indices respectively in their multi-factor models.

Nondefault components of investmentgrade bond spreads, Dignan, J. H. (2003). Financial Analysts Journal, 59(3), 93-102. This research paper was based on disintegrating between the spread lining risk-free debt and corporate debt but focus was delimited to exclusively on default risk.

Changing Leases into InvestmentGrade Bonds: Financial Alchemy and Cost Reduction in Real Estate Finance, Graff, R. (1999). Journal of Real Estate Portfolio Management, 5(2), 183-194. This research paper was based on the benefits of ownership economic from ongoing leases of real property and fro that of benefits of ownership of economic in the future leases.

Pricing efficiency in the secondary market for investmentgrade corporate bonds, Gehr, A. K., & Martell, T. F. (1992). The Journal of Fixed Income, 2(3), 24-38.

The pricing of investment grade credit risk during the financial crisis, Coval, J. D., Jurek, J., & Stafford, E. (2009). The pricing of investment grade credit risk during the financial crisis. Unpublished Working Paper, Harvard Business School and Princeton University. This paper deploy the use of structural models to researched into pricing of investment grade credit risk during the Financial crisis.

Should all tax‐exempt borrowers with investmentgrade quality acquire credit ratings?, Hsueh, L. P., & Liu, Y. A. (1993). Journal of Business Finance & Accounting, 20(2), 291-306.

 

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