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What are Credit Rating Agencies and Why are they Important?

It’s just the third month of the year 2020 and there are already enough news that took the markets on an extreme roller coaster ride. From Iran vs USA (the WW3 memes) to Coronavirus Outbreak, markets have been thrilling. On this day, i.e 20/03/2020, almost everyone’s portfolio or stock holdings are in negative. Some people have lost a large chunk of their profits while others have panicked and sold their holdings.

Still, in this capricious markets, there is a certain percentage of investors who are not worried about their investments because they know that their portfolio contain companies that have been rated the best score by the credit rating agencies.

Credit Rating Agencies are the companies that assign credit ratings to companies that raise funds through debt instruments. The timely payment of principal and interest along with the possibility of default is what determines the credit rating of the company. Credit Rating is a detailed report of the company’s financial history of borrowing and credit worthiness. It involves analysis of business risk, financial risk and management check.

The Credit Rating Agencies (CRA) analyse the financial position of company, their history of making payments and other essential factors. Higher the credit rating means that the company is financially sound and will most likely will not default in its payments. Lower credit rating means the company has already defaulted in past and hence will likely default in the future. There are a total of six credit agencies in India viz, CRISIL, CARE, ICRA, SMREA, Brickwork Rating, and India Rating and Research Pvt. Ltd.

Here is a quick view of how CRAs give ratings:

How Credit Rating is Important?
When you invest in any company for a good period of time, it is advisable for you to invest a decent chunk in high rated companies. This is because, when the markets fall, the high rated companies are less effective. The CRAs also make another task simpler: Filter companies based on risk. If you want high return, then you can opt for a low rated company, but if you want to keep your money safe and grow it over a period of time, you can go for high rated companies (that can also help during bad market times).

However, one should not completely rely on ratings only because these ratings track and analyse the history of the company. It can be possibility that the rating of a good rated company be downgraded. Therefore, the investor must look at all aspects while investing and credit rating should be used as one of the parameters during decision-making.

Here, I have tried to explain in simple words about what CRAs are and their importance during investing.
Thank you for reading.

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