Understanding the creditworthiness of issuers

Investors suffer a great deal when an issuer fails to pay interest in a timely manner or fails to repay the principal at maturity. Therefore, it is very important to consider the creditworthiness of issuers. Their balance sheets and credit ratings are indicative of their ability to repay the principal and interest. 

The simplest way to assess an issuer’s creditworthiness is by looking at its credit rating. Ratings are reviewed from time to time and adjusted if necessary. Any re-ratings usually lead to changes in the price of a bond.

Credit rating, as a measure of default risk, affects the market price of a bond

The two major categories of credit ratings are investment grade and non-investment grade, with the former denoting higher ratings.

Credit rating is considered a measure of an issuer’s credit or default risk. The higher the rating, the more credible the issuer is. Apart from the ratings given by independent rating agencies, some fund houses also have their own internal rating systems backed by in-depth analysis of bond issuers, for selection of companies when constructing bond funds. 

In addition, the credit rating of an issuer is also a factor that can affect its bond price. This should be considered if an investor intends to sell a bond before maturity. In case S&P or Moody’s downgrades an issuer, the market price of its bond will inevitably suffer a negative impact.  Selling a bond before it matures exposes an investor to this risk.