Page 33 - FINAL CFA SLIDES DECEMBER 2018 DAY 15
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LOS 55.e: Explain risks in relying on ratings
from credit rating agencies., p.130 Session Unit 16:
55. Fundamentals of Credit Analysis
Relying on ratings from credit rating agencies has some risks. 4 specific risks are:
1. Credit ratings are dynamic -change over time: Rating agencies may update their default risk
assessments during the life of a bond. Higher credit ratings tend to be more stable than lower
credit ratings.
2. Rating agencies are not perfect: Ratings mistakes occur from time to time. For example,
tanties
subprime mortgage securities were assigned much higher ratings than they deserved.
3. Event risk is difficult to assess: Risks that are specific to a company or industry are difficult to
predict and incorporate into credit ratings. Litigation risk to tobacco companies is one example.
Events that are difficult to anticipate, such as natural disasters, acquisitions, and equity
buybacks using debt, are not easily captured in credit ratings.
4. Credit ratings lag market pricing: Market prices and credit spreads change much faster than
credit ratings. Additionally, two bonds with same rating can trade at different yields. Market
prices reflect expected losses, while credit ratings only assess default risk.
