Credit Ratings the Company Research Paper

Pages: 18 (5610 words)  ·  Style: APA  ·  Bibliography Sources: 18  ·  File: .docx  ·  Level: Master's  ·  Topic: Economics

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Lastly, as it has beenexplained regarding the rules of NRSRO in the June 2007's adoptingrelease of the Commission, it is being studied by the Commission if itwill be suitable to require the disclosing of additional kind ofperformance statistics as an alternative or as an addition to thedowngrade rates and historical default like a credit rating downgradewhich takes place a long time after an important drop in the worth ofthe securities which are being rated. It is our believe that thedisclosure requirements according to the Rating Agency Act that willhelp the users of the credit ratings inevaluating an NRSRO's ratingreliability over a period of time and it will also help in increasingthe transparency with regards to an NRSROs' ratings accuracy (Dittrich, 2007).

Moody's, Standard & Poor's (S&P) and Fitch Group

When an individual is relying on someone's 'promise to pay', then thecredit worthiness of the person who is making the promise has the mostsignificance to the person who expects a payment. An independentmanner in which the credit worthiness of someone who has made apromise to make the payment can be judged is by making use of CreditRating. Today, a very important role is being played by the CreditRating in the finance decision making as, it helps in judging the riskof default as well as the credit quality (MIS, 2007; Fitch, 2007; S&P,

2005).

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It was in 1841 when credit rating was done for the first time by amercantile credit rating agency which was set up in New York. In thisagency the merchants' ability to pay their obligations regardingfinances was rated. Afterwards, Robert Dun took over the agency. Itwas in 1859 that the very first rating guide was published by theagency. In 1849 John Bradstreet established the second agency andlater on this agency was merged with the first one and in 1933 Dun & Bradstreet came into being. In 1962 this firm became the owner ofMoody's Investor's Service. The stone of Moody's Investor's Servicewas laid down byJohn Moody in 1900 as he rated the Railroad Companiesand published 'Manual of Railroad Securities' (MIS, 2007; Fitch, 2007;S&P, 2005).

Research Paper on Credit Ratings the Company Which Assignment

An expansion of the Credit Rating Industry took place in the early1920s when the first rating guide was published by Poor's PublishingCompany in 1916, soon after that Standard Statistics Company was setup in 1922 and Fitch Publishing Company in 1924. In 1941 Poor andStandard merged to form Standard & Poor. But no significant new CreditRating Agencies were set upfrom the years 1924 to 1970 (MIS, 2007;Fitch, 2007; S&P, 2005).

Since 1970 a lot of Credit Rating Agencies have been set up throughoutthe world. Some of the countries in which these agencies have been setup are Australia, Malaysia, Korea and Thailand etc. (MIS, 2007; Fitch,2007; S&P, 2005).

In the list of the developing countries India was probably the 1st oneto set up a Credit Rating Agency. This agency was set up in the middleof 1980s. CRISIL was the first Credit Rating Agency that was set up inIndia in the year 1988. Following this was the establishment of ICRAin 1991 and later on in 1994, CARE. Presently, there are 4 large ratingagencies that are present in India and these are CRISIL, ICRA, CARE andFITCH (MIS, 2007; Fitch, 2007; S&P, 2005).

The Credit Rating Agencies' functions were institutionalized when itwas made mandatory by RBI that commercial papers be issued and lateron by SEBI when credit rating was made compulsory by it for particularkinds of debt instruments. It was in June 1994 that rating the debtinstruments of Non-Banking Financial Companies was made compulsory byRBI (MIS, 2007; Fitch, 2007; S&P, 2005).

Even in these recent times when the economy all over the world facedthis slowdown, domestic agencies like ICRA or the international CreditRating Agencies like Standard & Poor's, Moody's Investors Services etc.have not been able to predict this slowdown. In fact, a lot of the financialinstitutions were given higher ratings by these agencies (MIS, 2007;Fitch, 2007; S&P, 2005).Around 50 to 100 companies were downgraded by other Credit RatingAgencies as a result of the public criticism that they faced.Following are some of the main reason for these downgrades:

There was a steep falling in the Service Company's earnings because ofthe recession being faced by the economy. The very overrated financialflexibility of companies by the rating agencies. Most of the financialflexibility was undoubtedly dependent on accumulating money for thenew issues in the capital market; this has been next to impossible todo because of the latest crash that took place in the stock markets (MIS, 2007; Fitch, 2007; S&P, 2005).

It was next to impossible for the financial institutions to raise anysort of money. The finance companies of this sort have the habit ofmaking investments in the long-term fixed assets by taking fixeddeposits of short-term nature. Liquidity problem was faced by themwhen the credit flow stopped (MIS, 2007; Fitch, 2007; S&P, 2005).

Overall rating gives a very good idea about the actual creditworthiness that a company has but it can't predict extreme scenarioslike the ones stated above which probably can't be predicted by many ofthe investors as well. Therefore, there is always a possibility ofsurprises (MIS, 2007; Fitch, 2007; S&P, 2005).

Role in Capital Markets

Accuracy and Responsiveness

Rating has proved to be very useful in various constituents of capital market. There are different benefits that can be achieved by makinguse of rated instruments for various classes of people.

1) Investors: By recognizing the risk safeguards are rated againstbankruptcy. It tells us about the risk which is present in aninvestment. The credibility of the issuing company can be evaluated.Information regarding the instrument quality is given by the ratingsymbols in a rather simpler manner which can be apprehended by a layinvestor and it can further help him in reaching a decision regarding theinvestment without getting help from a broker. The institutions aswell as individuals can draw up their own policies regarding creditrisk and evaluate the risk premium which is offered by market oncredit ratings' basis (Dittrich, 2007).

2) Issuers of Debt Instruments: A company which has highly ratedinstruments has higher chances of getting wider access to capital andthat too at a cost of borrowing which is relatively low. Best timingand pricing of issues is facilitated by rating and it also givesfinancing flexibility. Rating can be used as a marketing tool by thecompanies that have rated instruments in order to make a better imageof the company in customers', creditors' and lenders' eyes. Companies areencouraged by ratings to give more disclosures regarding theirmanagement patterns, accounting systems and financial reporting. Theinvestors who need mandated rating from renowned rating agencies tomake investments can also do so with the help of these ratings (Dittrich, 2007).

3) Financial Intermediaries: When it comes to decisions concerninginvestment and lending the financial intermediaries such as investmentadvisors, merchant bankers and banks find rating to be quite useful (Bolton et al., 2008).

4) Business Counter-parties: The business Counter parties find creditratings to be very helpful in the establishment of businessrelationships especially when it comes to opening letters of credit, getting into the collaborating agreements and awarding contracts etc.(Bolton et al., 2008).

5) Regulators: With some help from credit ratings, the entry barriersand eligibility criteria for new securities, promoting the efficiencydebt securities market, monitoring the financial soundness of firmscan be determined by the regulators. The transparency of financialsystem is increased by this which leads to a sound development of themarket (Bolton et al., 2008).

Rating and Default Risk

The use of credit ratings is preferred by many of the investors inorder to evaluate the default risk. Rating services are being offeredby the internationally renowned credit rating agencies such asStandard and Poor's, Moody's and Duff and Phelps. The rating agencies get paid by the bond issuers in order judge the worth of the issued bond so that the flow of information to the investors could be increased which would probably bring an increase in the demand for their bonds.Bond rating is determined by the rating agencies by taking many factors into consideration such as, the values of corporate bonds is evaluated by studying the bond indenture, future earning power, management and financial resources by Standard and Poor's. To be more precise the cash flow is mainly focused upon by Standard and Poor's in order to evaluate the financial viability of a firm. There are letter grades that are assigned to the categories of the bond. The highest grade bonds: these are the bonds that have negligible risk of default are rated as A (Aaa or AAA). Pluses or minuses (e.g.Aa+ A-)are assigned by the rating agencies whenever it's appropriate in order to show where the significant rating categories stand (Tasche, 2006).

Explanation of flaws and Excessive Power

When it comes to credit rating there are a lot of limitations. Firstly, there occurs a change in the credit ratings when it is felt by the agencies that a lot of change has taken place. It is physically not possible for the rating agencies to monitor all the firms that are present… [END OF PREVIEW] . . . READ MORE

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