Bond Ratings

Firms frequently pay to have their debt rated. The two leading bond-rating firms are Moody's and Standard & Poor's (S&P). The debt ratings are an assessment of the cred-itworthiness of the corporate issuer. The definitions of creditworthiness used by Moody's and S&P are based on how likely the firm is to default and the protection creditors have in the event of a default.

It is important to recognize that bond ratings are concerned only with the possibility of default. Earlier, we discussed interest rate risk, which we defined as the risk of a change in the value of a bond resulting from a change in interest rates. Bond ratings do not address this issue. As a result, the price of a highly rated bond can still be quite volatile.

Bond ratings are constructed from information supplied by the corporation. The rating classes and some information concerning them are shown in the following table.

Ross et al.: Fundamentals of Corporate Finance, Sixth Edition, Alternate Edition

III. Valuation of Future Cash Flows

7. Interest Rates and Bond Valuation

© The McGraw-Hill Companies, 2002

CHAPTER 7 Interest Rates and Bond Valuation

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