Credit Rating can be simply defined as a data backed up opinion of rating agency which reflects the ability and willingness of the manager of debt instruments to fulfill its debt obligation when required. In simple terms, credit ratings rank the issuer and debt instruments on the basis of their ability to fulfill the debt obligation. Credit Ratings are usually expressed in alphabetic and alphanumeric symbols.
Ratings help to differentiate and rank various debt instruments and their issuer on the basis of their underlying credit quality. Credit Ratings are very useful in understanding the quality of instruments or ability of the company and assist in informed investment decisions. Investors usually use credit ratings to optimize their risk-return trade-off.
Credit Ratings are important for both the parties; investors and issuer companies. Investors can make informed decisions with the help of credit rating and the issuer company can also take advantage of credit ratings of its instruments. Some of the advantages of credit ratings are:
Benefits to Investors
Safe Investment Environment
Credit Ratings provide a prior approach to understanding the instrument and issuer company. Based on the advance information and ratings, investors invest on the desired instrument which qualifies their expectation. High rated instruments assure investors the instrument to be safe but return on investment is low and vice versa.
Recognition of Risk and Return
Credit rating is also the reflection of risk factors of various financial instrument. Higher rating signifies low risk of default and low rating reflects high chance of default. Credit ratings make work easier for investors to understand the worth of the instrument and issuer. Similarly, investors can assign and evaluate the risk-return factors associated with the instruments.
Freedom of Investment Decision
Credit Ratings is a publicly published document which reflects the potential of the instrument. Investors can rely upon these ratings for making their investment decision. Investors do not need to consider stock brokers, merchant bankers, portfolio managers, independent advisors etc. about the creditworthiness of the debt instrument with credit ratings. This is the freedom for investors in their investment decision.
Wider Choice of Investment
It is very essential for the issuer company to rate their debt instrument to increase the confidence of investors for their high rating issues. Similarly, there are multiple issues from multiple organizations and credit rating defines each issue and investors can choose the needed investment from this available variety of rated debt instruments.
Easy understanding of investment proposals
Credit rating agencies publish the final rating after considering various factors related to the particular instruments. The final rating published is denoted by alphabetical or alphanumeric symbols. Each symbol has some significance. Therefore, looking at these symbols, investors can easily understand the worth of the instruments.
Relief from botheration to know company
Credit rating is the final valuation of the debt instruments. The credit rating is alone capable of reflecting various information from its alphanumeric and alphabetic representation. Credit rating saves investors from hectic work company analysis and other valuations.
Advantages of continuous monitoring
Credit Rating is a continuous approach until the instrument is available in the market. Unlike other valuation. Credit rating is a continuous approach where the rating of instruments upgrade and downgrade subject to market factors.
Benefits to the Company
Easy to raise resources
Credit ratings measure multiple aspects of an instrument. A company with highly rated debt has probably the higher chances to raise funds from the market. The ratings of different instruments attract different sets of investors i.e. investment decision is informed and hence matching instruments with investors is easier.
Reduce the cost of borrowing
Credit Rating allows a match of risk-return factor associated with the instruments. Higher rated instruments means the chance of default is low or is secure investment and hence the return i.e interest on such instrument is lower. The issuer company will have enough ground to define market value of their instrument. A higher rated debt will have lower cost of borrowing.
Reduce the cost of public issues
A high rated instrument will have to face less challenges in attracting investors for raising funds. Also, credit rating will attract only those investors who are interested hece cost will be reduced as unwanted subscription while raising funds is minimized.
Rating reflects image
Credit rating is done for instruments but ratings can influence the image of the issuer as well. An issuer with high rated debt in its portfolio will definitely enjoy the goodwill and corporate image. The investors, customers, shareholders and creditors are assured about the issuers as the debt issued is highly rated. Everyone feels safe with their association with such an issuer.
Rating facilitates growth
Ratings attract the desired investors. A high rate debt instrument will have desired investors and raising of funds will not be an issue. This provides companies with an expansion strategy diversifying their business and operations. Highly rated companies will never feel shortage of funds as there are investors ready to invest on their highly rated goodwill.
Recognition of new/unknown companies
Rating is not preferred by all the issuers. As rating involves disclosure of information, many new issuers prefer not giving this. A-rated issue in the market will have more credentials than a normal public issue. Investors are sure about the credit rating as someone has conducted an analysis for such issues. Similarly, an unknown company gets some recognition in public issues due to credit rating.