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Understanding Risk

 

The Same Rating from Different Agencies Only Looks the Same

 

Don't be fooled by appearances. There are now dozens of rating agencies to choose from in various markets around the world. And most of them publish their long-term risk opinions using the same triple-A-through-C rating symbols that have been the market standard since John Moody introduced them in 1909.

 

But ratings are opinions about risk, not formulas. Accurate, forward-looking credit analysis cannot be mechanized. As an investor, you cannot assume that a given letter rating from different agencies indicates the same degree of credit risk. As a borrower, you cannot assume that a rating from any agency will provide the same degree of access to the sources of investor capital.

 

How do you decide which agency provides the greatest value? One test is the degree to which the markets actually use its ratings in day-to-day securities pricing decisions. Looking back, the record shows that capital market participants have relied on Moody's ratings in the buying and selling of securities for nearly a century.

 

Ultimately, though, the only true test of a rating agency's future value comes from "kicking the tires." Compare the agency's ratings with those of other agencies in specific cases. Read its research. Look at the breadth of rating coverage and investor base. Examine its rating process and track record for accuracy. Ask other market participants.

 

Above all, talk with the agency's analysts. In understanding credit risk, professionalism and the all-important credit sense are hard to define. But you'll know them when you see them.

 

~In virtually every period over most of the twentieth century, bonds rated Aaa by Moody's have consistently had the lowest yields, thus representing the lowest funding costs for their issuers. And bonds rated lower by Moody's have commanded the consistently higher yields that investors demand in return for greater expected credit loss.~