Understanding Bond Ratings and Their Importance

‘AAA to Battery ka size hota hai na?’

My cousin, Neeraj, is a government employee from Jaipur. He decided to invest ₹5 lakh in bonds last year, so he chose the one with a 10.5% return. Six months later, the company and interest payments both were ‘gadbad’. Later, he discovered it was rated ‘BB-’, indicating a high risk. 

Had he checked ratings, he’d have chosen an ‘AAA-rated’ bond offering 8.2%. ‘Thoda kam mile, lekin time pe mile.’ Let’s see how Neeraj’s investment might have looked with better rating awareness:

I know that most of us are unfamiliar with bond ratings. But if you’re putting your hard-earned money into something, shouldn’t you know how to tell the good ones from the bad? Don’t worry, this article has got you. After reviewing it, you will understand and compare the bonds based on their ratings and the relevant factors.

What Are Bond Ratings?

Bond ratings are like a report card for loans. Just as students receive grades for their performance, bonds are rated based on their safety for investors. The higher the rating, the more likely the borrower (typically a company or government) is to repay on time. ‘CIBIL score ka UNO reverse!’

Bond ratings are assigned by specialised agencies such as CRISIL, ICRA, and CARE in India, and S&P, Moody’s, and Fitch globally. Their job is to assess the riskiness of a bond and assign it a letter grade, much like the grades we received in school. ‘Trauma tha vo toh!’

Here's a quick breakdown of standard ratings:

So if a company offers a bond with a BBB rating, it’s considered stable, but not as safe as an AAA-rated bond. Investors use these grades to judge how much risk they’re taking on and whether the higher return is worth it.

How Are Bond Ratings Assigned?

A few months ago, I lent money to two of my friends. One always repays on time, earns well, and doesn’t owe anyone else. The other has pending loans, irregular income, and a poor repayment history. Naturally, I felt more comfortable lending to the first friend.

Rating agencies do something similar, just with a lot more data and math. Here are the main factors they look at:

For example, Anita bought a ₹1 lakh AAA-rated government bond. It was safe and steady. Her friend Rohit went for BB-rated startup bonds from BrewX, a new coffee chain promising 15% returns. Months later, BrewX struggled 

with sales, while Anita's bond continued to pay her like passive income. Safety > thrill. Here is that tabular comparison between both of their choices:

Long-Term V/S Short-Term Bond Ratings

Let me share something that happened to my cousin Sumeet last year. He invested in two bonds, one a 5-year government bond and the other a 9-month corporate bond. A few months in, the corporate bond delayed payments, while the government bond paid steadily.

That’s when he learned that not all ratings mean the same thing. Some are for the short term, while others are for the long haul.

Bond ratings are broadly classified into two categories:

• Short-Term Ratings: These apply to bonds or instruments that mature within 1 year.
  
  
• Long-Term Ratings: These are used for bonds with a maturity period of more than 1 year, often 3, 5, or even 10+ years.
  
  

Here’s a table to break it down clearly:

Conclusion

Have you ever run a red light or skipped a traffic signal? Mostly, that ends up being a bad decision, well, at least for me. Similarly, if you ignore bond ratings, be prepared to face a greater loss than you expected. Understanding these ratings enables you to compare risk and return effectively. If your bond rating is AAA, then a slightly lower return will suffice, as it would over a BB-rated bond offering higher returns. ‘Sasta nahi, sabse acha!’

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LoansJagat Team

We are a team of writers, editors, and proofreaders with 15+ years of experience in the finance field. We are your personal finance gurus! But, we will explain everything in simplified language. Our aim is to make personal and business finance easier for you. While we help you upgrade your financial knowledge, why don't you read some of our blogs?