At the latest, the subprime crisis in the USA and the sovereign debt crisis in the Eurozone have made it clear that this risk is by no means limited to niche investments from the second and third tier. The judgements of rating agencies were not always of record accuracy in these crises, but they still represent the basis for the assessment of default risks of debt securities.
What duration and convexity do not tell us
Both duration and convexity are used exclusively to assess systematic risk and say nothing about the default risk of a particular bond (apart from a possible indirect statement of the price or coupon, which is also reflected in the ratios). The composition of a bond portfolio solely on the basis of these two sensitivity ratios is therefore not expedient.
How do rating agencies work?
At the heart of every rating is the question of the issuer's ability to meet its payment obligations (interest and repayment of the bond) on time. Rating agencies take into account various balance sheet ratios (e.g. cash flow, reserves) and other "soft" factors such as the quality and experience of management.
Rating agencies can assess the creditworthiness of companies both on their behalf (with a mandate) or without a mandate. If the latter is the case, the ratings are based on publicly available sources such as balance sheets and annual reports. If a company gives an agency a mandate, it pays a fee for the credit rating and usually provides the agency with further data material. Depending on the scope of the mandate, internal company processes and data collection are then also taken into account.
Investors in Exness mt4 cannot see from the published rating results on what basis a credit rating is based. Even conflicts of interest cannot be ruled out. Firstly, a rating agency must reckon with the withdrawal of the mandate (and thus also of the fee) in the event of a conflict of interest from the point of view of the company being rated.
Rating agencies and conflicts of interest
Secondly, in the case of ratings without a mandate, rating agencies may be tempted to set the ratings somewhat lower with reference to the smaller information base: Primarily in order to avoid an ex-post rating that is too positive and thus a loss of their own image, but secondarily possibly also in the hope of being awarded a mandate. This conflict of interest cannot be ruled out, especially in the case of small agencies without a reputation and with a manageable client base.
Of the many internationally active rating agencies, only three US agencies are globally known: Standard&Poors, Moody's and Fitch Ratings. Fitch Ratings was founded in 1913, employs about 2300 people and has a turnover of about 550 million euros. Standard&Poor's was founded in 1941, employs 8500 people and has an annual turnover of 2.9 billion USD. Moody's was founded in 1909 and has 4700 employees and an annual turnover of 2 billion USD.
The grades of the rating agencies
Rating agencies summarise their assessment of creditworthiness in grades. The agency Standard&Poor's rates both the creditworthiness or default risk of bonds (English: issue) and the debt service capability of issuers without reference to individual bonds. In addition, there are ratings for short- and long-term periods. The following is the (free) German translation of the rating categories for long-term bond ratings (Long Term Issue) of the Standard&Poor's agency. The English original can be viewed here