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A study on the credit rating process and methodology

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  1. Introduction
  2. Objectives of credit rating agencies
  3. Advantages of credit rating
  4. Credit rating methodology
    1. Bond/debenture rating
    2. Equity rating
    3. Commercial paper rating
    4. Fixed deposits rating
    5. Individuals rating
    6. Mutual fund rating
    7. Rating structure obligations
  5. Credit rating process
    1. Receipts of information
    2. Analysis of information
  6. The major ratios computed
    1. Coverage ratio
    2. Financial leverage ratio
    3. Liquidity ratio
    4. Cash flow ratio
    5. Profitability ratio
  7. Business profile
  8. Granting rating symbols
  9. Criteria for credit rating
  10. Objectives of a credit rating company
  11. Strategy of a credit rating company
  12. Credit rating process in a credit rating agency
  13. Rating symbols used by a credit rating agency
  14. Disadvantages of credit rating

Credit rating is the process of estimating a firm's ability to perform to its capacity. It also determines the financial worthiness of an organization depending on the performance of the organization in the past.

Objectives of credit rating agencies
1. Its primary objective is to provide guidance to the investors, creditors in determining the credit risk associated with debt instrument.
2. To shift the primary burden of establishing corporate credit quality from the broker/underwriter to the rating agency and thus lessen potential conflicts of interest between underwriter and investors.
3. Provide an increased disclosure, better accounting standards and improved financial information to institutional investors.
4. Encourage the direct mobilization and saving from individuals rather than from intermediary lending institution.
5. Providing benefits to the borrowing company by:
a) Reducing interest cost for higher rated companies.
b) Providing a marking tool in placing its debt obligations with an investor's base level of risk.

[...] The major ratios computed are: Coverage Ratio: Coverage ratio is a measure of how many times the issuing company earned income and how the issuing company could pay the interest charges and other cost related to the debt issue. Financial Leverage Ratio: It is a set of ratios to assess proudly what is the mix of funds source. Liquidity Ratio: To know the firms ability to pay debts currently coming due, liquidity ratios are calculated. Cash Flow Ratio: If cast flow of a company is sufficient in relation to interest payment liability and total long term debts, the debt instruments of the company may get higher rating. [...]

[...] Criteria for credit rating Past performance of the company and the prospectus Coverage Ratios Interest Cover Debt Service Coverage Ratio Net Cash Accruals to total debt Capital Structure Gearing Total debt/Tangible Net worth Total debt/Adjusted Net worth Total debt + off balance sheet funding liabilities/TNW Total debt + off B/S liabilities/Adjusted Net Worth Credit Enhancements Group Support Objectives of a credit rating company To assist investors in making investment decisions To assist issuers in raising funds from a wider investor base To provide a marketing tool to entities placing debt with clients To institutionalize a viable and market-driven system of credit rating Its rating provides a guide to the investors as to risk of timely payment of interest and principal on a particular debt instrument. [...]

[...] The data base of the rating agency about industry concerned is also extensively used. Following this review and discussions, the primary analyst makes a recommendation and a rating committee meeting is conveyed. The committee discusses the recommendations and the pertinent facts supporting the rating. The borrower is subsequently notified of the rating and the major supporting consideration. Borrower or client has option not to accept the final rating and the company will not publish the rating or monitor it. A borrower can appeal against a rating decision prior to its publications. [...]

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