How is the quality of a bond measured?

When you buy a stock or a share, you will make an informed choice based on your knowledge of a company. There may be ratings in a newspaper that say to sell a company, to buy it, or to hold and so on - but there is no clear assessment of how attractive an investment a company is and what the quality of its shares is, as it were.

When it comes to bonds, being a fundamentally different product, that is very much not the case. In fact there is a neat ratings system that tells you exactly what the quality of a bond is perceived to be.

Therefore those that are assessed to have virtually no risk of defaulting are clearly seen as a better product and therefore trade more expensively than much riskier ones that may not pay out.

There are two main agencies that assess credit quality and give ratings, and these agencies are called Moodys and Fitch and Standard and Poors.

You will not be studying bonds for long before you come across the names of those two companies and also their bond ratings. The best quality of bond is a triple AAA. After that they descend in order, either using pluses or minuses, e.g. AA+, or using numbers, with the lower number being used to denote a better quality bond, e.g. aa1 is better than aa2.

Another term you will encounter is "investment grade bond". This refers to those rated BBB- or baa3 upwards and is an important threshold because a bond does not want to fall below this and not be considered investment grade!

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How is the quality of a bond measured?

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