Default Risk and Interest rates

When banks did much of the lending to firms, it made sense for banks to expend the resources to make their own assessments of default risk, and they still do for most lenders. The advent of the corporate bond market created a demand for third party assessments of default risk on the part of bondholders. This demand came from the need for economies of scale, since few individual bondholders had the resources to make the assessment themselves. In the United States, this led to the growth of ratings agencies like Standard and Poor's and Moody's which made judgments of the default risk of corporations, using a mix of private and public information, converted these judgments into measures of default risk (bond rating) and made these ratings public. Investors buying corporate bonds could therefore use the bond ratings as a shorthand measure of default risk.

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