AAA Rating – Definition
The AAA rating is like a credit score; it is the highest rating a company or country can receive. These types of ratings start at AAA at the top (highest grade) and then drop to AA, A, BBB, all the way down to C (lowest grade, or “junk”) and finally D (in default for non-payment of principal or interest). Such ratings are issued by a credit rating agency that looks at the financials of a country or company to determine its ability to service and repay debts. Since companies and countries issue bonds (a security where you give the issuer money now, and they pay you later, with interest)–which are debt–companies, countries and the bonds they issue are all given a rating.
Further Explanation of the AAA Rating
Investors look at the rating of a bond to assess whether they want to invest in it. Higher rated bonds are considered safer, and therefore the issuer typically provides smaller interest payments. Less credit worthy companies and countries need to pay higher interest rates in order to attract investors, as investors want to be compensated with a higher return for the increased risk they are taking in a buying a lower quality bond.
The AAA rating and AA are high quality bonds, also known as investment grade. You are very likely to receive your money back, with interest, but the interest paid is usually lower than what you will see in lower rated bonds.
A to BBB are medium quality bonds. Interest you receive is likely to be a bit higher than a comparable AAA rating or AA bond.
BB down to C are lower quality bonds, referred to as “junk bonds.” Companies and countries in this category typically offer higher interest payments than companies and countries with a higher rating. While there is more risk in this category, there is a the possibility of finding some “diamonds in the rough.” With some research investors can receive more interest and help reduce their risk by investing in a basket of junk bonds they feel offer reasonable assurance of payment. Keep in mind, if something sounds too good to be true, it probably is. Companies and countries don’t offer massive interest payments unless they are desperate, and a company or country in a desperate situation isn’t the most reliable place to invest capital. Assess whether the reward is worth the risk.
D is a category reserved for companies or countries already in default on some of their debts. The average investor has little need to look for investments in this category, and hopes that their current investments don’t reach a D rating.
Rating are somewhat controversial because credit rating agencies are often slow to react when conditions within a company or country
change. The credit rating agencies didn’t see the risk during the 2008 financial crash, maintaining high ratings on companies that ended going bankrupt or required government bailouts. Doing some of your own research, and not implicitly trusting others, is always advised.
Further Reading on AAA and Other Ratings
Country Credit Ratings (along with detailed description of ratings at bottom)