Credit ratings are shorthand assessments of an issuer's ability to meet its financial obligations. The three major agencies — Standard & Poor's, Moody's, and Fitch — assess corporations, governments, and structured finance vehicles, then assign a letter rating that reflects their view of default risk.
The broad structure
Ratings divide into two camps: investment grade (higher quality, lower default risk) and high yield or 'speculative grade' (lower quality, higher risk, higher yields). The dividing line between the two is one of the most commercially significant boundaries in financial markets: many institutional investors — pension funds, insurance companies, money market funds — are legally or contractually restricted from holding below-investment-grade bonds.
Within each broad category, ratings are subdivided into finer gradations. Bonds at the lowest investment-grade level are commonly called 'BBB', and when a company falls from the lowest investment grade to the highest high yield, it becomes a 'fallen angel' — a name that reflects the sharp and often sudden price dislocation that accompanies the downgrade.
Why ratings matter for the markets business
Credit ratings affect pricing, capital requirements, and investment eligibility simultaneously. A bond's credit spread — the extra yield above the risk-free rate — is closely related to its rating. Banks must hold more regulatory capital against lower-rated positions. And a single rating downgrade can force simultaneous selling from all IG-mandated investors, creating a supply shock at exactly the moment the issuer's creditworthiness is being questioned.
Traders, salespeople, and risk managers all use ratings as a starting point, but they know the agencies are backward-looking. Credit default swap spreads — reflecting real-money views on default probability — often anticipate rating changes by weeks or months.
How to read a rating agency methodology, what specific spread ranges correspond to what rating categories, and how fallen angel dynamics create trading opportunities are all explored in depth in Market Mechanics — the complete plain-English guide to how a bank's markets business works.