Definition and Example of AAA Bond Rating (AAA)
How AAA Bond Rating Works (AAA)
What It Means for Individual Investors
Alternatives to AAA Bonds (AAA)
Definition and Example of AAA Bond Rating (AAA)
AAA bond ratings are considered the highest rating granted by rating agencies for investments deemed to carry extremely low risk of default, making them the most creditworthy.
AAA bonds are classified as the safest by three major bond rating agencies: Fitch, Moody’s, and Standard & Poor’s. Fitch and Standard & Poor’s rate bonds from “D” to “AAA”, while Moody’s rates bonds from “C” to “AAA.”
Achieving a AAA rating is exceptionally difficult. American companies that have maintained AAA ratings include Johnson & Johnson and Microsoft.
By assigning a AAA rating, bond rating agencies express their utmost confidence in these entities’ ability to fulfill the terms of the bonds. In other words, they believe there is a very high chance of recovering your investment.
How AAA Bond Rating Works (AAA)
Bond rating agencies consider various metrics to determine the safety of a bond as an investment. These include the issuer’s financial strength, the likelihood of generating enough earnings and cash flows to cover the promised interest and principal payments, and the guarantees available to seize in case of defaulting on the bond before or at its maturity date.
Bond ratings are not permanent and can change due to the issuer’s circumstances. For example, the global credit crisis in 2008 caused companies like General Electric (GE) and Berkshire Hathaway to lose their AAA ratings.
What It Means for Individual Investors
With lower risk comes lower rewards. Due to their low risk and strong standing, AAA-rated bonds typically offer the lowest yields. What you gain in peace of mind, you lose in income.
On the other end of the spectrum are junk bonds, which carry low ratings and high yields. They are also known as “high-yield bonds.” Companies issuing these bonds receive poor ratings because credit rating agencies determine that they are at risk of defaulting (or may have defaulted in the past).
Individual investors looking to invest in bonds will need to choose the level of risk and return they are comfortable with, knowing that if they opt for AAA bonds, their investment will be safer but will provide a lower return than if they choose lower-rated bonds.
Alternatives to AAA Bonds (AAA)
AAA bonds belong to a broader category of bonds known as “investment-grade bonds.” Investment-grade bonds include any bond rated at BBB- or higher (on the S&P and Fitch scale) or Baa3 (on the Moody’s scale). This carries significant regulatory implications. For example, a banking trust department or pension fund may prefer investment-grade bonds over lower-rated bonds due to a strong desire to maintain a stable balance.
The rating system may break down somewhat when comparing investment-grade corporate bonds with government bonds such as Treasury bonds and bank bonds also known as “treasuries.” While a company like Microsoft may be able to issue AAA bonds, U.S. Treasury bonds are generally considered the safest bonds. This is because they carry the full weight of the U.S. government.
Not all government bonds are as secure as Treasury bonds. Municipal bonds (“munis”) are issued by lesser governmental bodies. They can be issued by state authorities, cities, or local agencies like school districts.
Municipal bonds can also be issued by U.S. territories like Puerto Rico. Since these bonds are not issued by the federal government, they do not carry federal backing. The relative safety of investing in municipal bonds varies by the issuing entities.
Source:
https://www.thebalancemoney.com/aaa-rating-triple-a-357798
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