AAA Rating: What Does It Mean?
Believe it or not there are some agencies whose sole purpose is to predict the likelihood of a company’s or even a country’s ability to pay back the debts they owe. The methods they use to determine this are similar but take into account the economic health of the company or country in question which includes the revenues, current debt and long term debt and current policies that affect revenues and debts. Investors decide whether or not to invest based on the credit rating first and several other factors second.
Although there are several different credit agencies, there are four main sources that investors turn to when seeking advice on which country or company to invest in. These include Moody’s, Standard and Poor’s, Fitch and the Dominion Bond Rating Service (DBRS). The scale each uses is similar but runs the gamut of being considered a ‘prime’ investment to being in default. The rating for ‘prime’ investments is known as triple A rating.
As with investing in any specific company or country if you are buying bonds, (i.e. investing in the country’s debt), the better the credit rating, the safer the investment. And the safer the investment, the less return you get on your investment. To increase the return on your investment sometimes an investor will gamble on a company or country with a higher risk in the hopes of a higher return. Unfortunately, when dealing with a country, the investors who are buying bonds are financing the government’s plunge into debt.
As many in Europe learned this last year by investing in a failing Greece, much of the investment they made was lost when Greece defaulted on their loans. With the increased burden of spending in excess of revenues, even the United States has fallen into the same situation as Greece. America’s AAA credit rating was lost in August of 2011 and downgraded two levels to an AA rating. Less than a full year later, the credit rating for the US lost another notch.
What does this mean? It means that investors are more reluctant to invest in the debt when there is an ever increasing chance that the debt won’t be repaid. Fewer investors mean less cash to spend and can bring the gears of a company or country to a screeching halt.