AAA

By:

James Knight

James is the Editor of Education for Invezz, where he covers topics from across the financial world, from the… read more.

Updated: Jan 20, 2023

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What does AAA mean?

It is the highest rating given to bonds by rating agencies.

AAA bonds are virtually risk free. The most important rating agencies are Moody’s and Standard & Poors.

AAA is the highest rating that an agency can give a bond issuer. An AAA-rated bond has an exceptional degree of creditworthiness because the issuer can easily meet its financial commitments. Standard & Poor’s (S&P) and Fitch Ratings use the AAA rating to identify the bonds with the best credit quality, while Moody’s has AAA as its highest rating.

AAA Explained

“Default” is the risk that a bond will not make a payment. Since AAA-rated bonds are believed to have the lowest risk of default, they often offer lower dividends than other bonds with similar maturity dates. The global credit crisis of 2008 caused several companies, including General Electric, to lose their AAA rating. By mid-2009, only four companies in the S&P 500 held the coveted rating.

AAA Definition – How It Can Help a Business

A good rating lowers the cost of borrowing for a debt issuer and allows companies to borrow more money. A low cost of borrowing is a great competitive advantage, as it allows a company to easily borrow to take advantage of opportunities. If, for example, a company has the opportunity to start a new product line or buy from a competitor, it can borrow money to finance the operation.

Meaning of AAA – Secured and Unsecured Bonds

Issuers can sell both secured and unsecured bonds, with different default risks for each. A covered bond has an asset as collateral. If this bond defaults, the creditor has a claim on the asset. The collateral for these bonds is equipment, machinery, or real estate. Therefore, covered bonds have a higher credit rating than unsecured ones, even though both are issued by the same entity.

On the other hand, an unsecured bond is only backed by the issuer’s ability to pay. The rating of this class of bond depends on the issuer’s sources of income.

Differences between Revenue Bonds and General Obligation (GO) Bonds

Municipal bonds can be income or general obligation, and each of these types relies on a different source of income. For example, revenue bonuses are paid through fees or revenue from a specific source, such as a municipal swimming pool or sports venue. For their part, general obligation bonds are backed by the ability of the issuer to collect taxes. State bonds rely on state taxes, while school districts rely on property taxes.