Today the market is too wide when we
see it. Thus the business risk and payments risk have became one of the most
important concern for the any firm. To solve the payment risk problem credit
rating has came into existence. Today in this article let us discuss about the
credit rating meaning, need or importance of credit rating, factor affecting
credit rating and nature of credit rating.
Credit Rating
Credit Rating refers to the relative ability and willingness of the
issuer of a debt instrument to meet the debt obligation whenever the need
arises. Credit rating is usually expressed in alphabetical or alphanumeric
symbols so that it is easy and simple to understand and facilitate investor to
differentiate between debt instruments
based on credit rating. Credit Rating is a symbolic indicator of the current
position to meet the debt obligation of a firm or an organization.
Need of Credit Rating
The need or importance of the credit
rating is based on the link between risk and return. The investor studies the
rating and assesses the risk level and compares it with the rate of return.
In the absence of the credit rating
system it largely depends on the familiarity of the names of promoters or
collaborators. But the problem is that the corporate issuer of the debt
instrument may not be able to provide an investor an opportunity to undertake a
detailed risk evaluation and also different class of investors may not be able
to come to common conclusion quality of the instruments. Thus the need /
importance of credit rating is as follows,
§ It helps investors to make investment decisions.
§ It helps the issuer of to price the instrument properly and attract
the new investors.
§ Regulatory bodies use credit rating to determine eligibility
criteria of some instruments.
§ It helps to improve the quality of the consciousness in the
market along the time and more
meaningful relationship between quality of debt and its yield.
Factors Affecting Credit Rating
Various factors affect the credit
rating of the firm or company. Following are generally factors that influence
the credit rating agency with assigning the credit score to a firm or company.
§ The security issuer’s ability to service its debt.
§ The quantity and composition of outstanding debt.
§ Stability of the future cash flow and earnings of the company.
§ The ability of the issuer to meet fixed interest obligation.
§ Ratio of current asset to current liabilities.
§ The asset value pledged for debt as collateral security and the
priority of the company to claim back the asset.
§ Assessing the market position of the firm on the basis of the
demand of the products of the company in market, competitors, market share,
distribution channels and more.
§ The operational efficiency on the basis of the capacity
utilization, prospects of expansion, modernization and diversification of the
assets and the availability of the raw material and more.
§ Track record of the promoters, directors and staff expertise.
Nature of Credit Rating
§ Rating Is Based On Information:
The rating is
purely based on the ability of the published information and to a greater
extend depends on the ability to access the privileged information. The
cooperation and willingness of the issuer of sharing the confidential data with
the credit rating agency is one of the most pre-requisite and also the credit
rating agency will then has to maintain the confidential data as secret which
is shared during credit rating process.
§ Rating By More Than One Agency:
In well
developed capital market the problem is various credit rating agencies exist
and all of them provide different rating for a single company because each one
has different information or evaluation criteria of the agency or even
sometimes the expertise staff varies with the agencies as a result of this the
ratings also vary.
§ Monitoring Of Already Rated Issues:
A preexisting
rating will be available for various company but it is based on the information
that was available at a particular time. Debt services are affected by various
factors of the issuer thus it becomes important function of the credit rating
agency to monitoring of an agencies of all outstanding debt rated issues as a
part of investor’s service.
§ Right Of Appeal Against Assigned
Rating:
When a issuer
is not satisfied with the rating assigned he can ask for he review and the can
provide additional information the credit rating agency will then undertake the
review and will check if any critical data has not been evaluated or missed out
in the initial stage of the rating process and will take a final decision at the
end
§ Rating Of Rating Agencies:
The credibility
of the credit rating agencies depend on the informed public opinion which is
assessed by the quality of the services offered, consistency and integrity.
§ Rating Is For Instruments And Not
For The Issuer Company:
The most
important thing to remember is that credit rating is given to the issuer and
not the company. There is a possibility that two different instruments may have
different ratings when one of the instrument is backed by credit rating
reinforcement like guarantees.
§ Many Factors Affect Rating:
Credit Rating doesn’t have a
predefined mathematical formula or
equation rather rating is finalized after taking into account various
things such as quality of management, corporate strategy, economic outlook,
international environment and many other factors. The committee which decides
the credit score of any firm is specialized in financial analysis & credit
analysis.
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