FRM Exam Part I · External and Internal Credit Ratings

Credit Rating Agencies and Rating Scales: S&P, Moody's and Fitch

Updated 11 October 2026 · Fact-checked

Credit rating agencies such as S&P, Moody's and Fitch assess a borrower's or a bond's creditworthiness and express it as a letter grade. AAA/Aaa is the strongest. BBB-/Baa3 and above is investment grade; BB+/Ba1 and below is speculative grade. To solve questions, map the rating to its grade band and note whether it is an issuer or issue rating.

Understand Credit Rating Agencies and Rating Scales

A credit rating is an opinion on how likely a borrower is to meet its debt obligations. The three big agencies are S&P Global Ratings, Moody's and Fitch. Investors use ratings as a quick summary of default risk, so they influence bond yields, fund mandates and regulatory capital.

Agencies use letter scales. S&P and Fitch use AAA, AA, A, BBB, BB, B, CCC, CC, C and D (default), with + and - modifiers from AA to CCC. Moody's uses Aaa, Aa, A, Baa, Ba, B, Caa, Ca and C, with numeric modifiers 1, 2 and 3 from Aa to Caa. Moody's 1 is the higher end of a category and 3 the lower end.

The key divide is investment grade versus speculative grade (also called high yield or junk). Investment grade is BBB- or better (S&P, Fitch) and Baa3 or better (Moody's). Anything lower is speculative grade. Many pension funds, insurers and banks are restricted or penalised for holding speculative grade debt. So a downgrade across this line can force selling, widen spreads and raise funding costs. This is often called the fallen angel effect.

Ratings apply at two levels. An issuer rating (or counterparty rating) reflects the borrower's overall capacity to pay its senior unsecured obligations. An issue rating applies to a specific debt instrument and depends on seniority, security and expected recovery as well as default probability. A subordinated bond of an A-rated issuer can carry a lower issue rating than the issuer rating. A secured senior bond can carry a higher one.

Agencies assign ratings through a mix of quantitative analysis (leverage, cash flow, coverage ratios, industry and country factors) and qualitative judgment (management, governance, business position), then a rating committee votes. The issuer usually pays the agency (the issuer-pays model), which creates a potential conflict of interest. Ratings are monitored and may be put on watch or given an outlook (positive, stable, negative). A rating is an ordinal ranking, not a precise default probability.

Key formulas to remember

Investment grade boundary: Investment grade: S&P/Fitch ≥ BBB-; Moody's ≥ Baa3; One notch below (BB+ / Ba1) is speculative grade.
Scale order (S&P/Fitch): AAA > AA > A > BBB > BB > B > CCC > CC > C > D; + and - modifiers sit within AA to CCC categories. Example: BBB+ > BBB > BBB-.
Scale order (Moody's): Aaa > Aa > A > Baa > Ba > B > Caa > Ca > C; Modifiers 1, 2, 3 apply within Aa to Caa. Example: Baa1 > Baa2 > Baa3.
Equivalent mapping: AAA=Aaa, AA=Aa, A=A, BBB=Baa, BB=Ba, B=B, CCC=Caa; CC ≈ Ca and C ≈ C (approximate); D (S&P/Fitch default) has no Moody's equivalent; AA+ = Aa1, AA = Aa2, AA- = Aa3, and so on. The CC to Ca and C to C links are approximate equivalences, not exact ones. C is the lowest Moody's rating. Moody's has no D category.
Issuer vs issue rating: Issue rating = issuer rating adjusted for seniority, security and expected recovery; Subordination usually lowers it; strong security can raise it.

How to solve Credit Rating Agencies and Rating Scales questions

Use this routine for any question on agencies, scales or grades.

1Identify the agency and write its scale: S&P/Fitch letters with + and -, or Moody's with 1, 2, 3.
2Convert to a common scale if two agencies appear (Baa3 = BBB-, Ba1 = BB+).
3Find the investment grade line: BBB- / Baa3 is the lowest investment grade.
4Decide if the rating is an issuer rating or an issue rating, and check seniority or security clues.
5Count notches carefully. Each modifier step is one notch, and BBB- to BB+ is one notch.
6Link the result to consequences: spreads, investor restrictions, funding cost or capital treatment.
7Check the wording: ratings are ordinal opinions, not exact default probabilities.

Quickest way: Grade-line check

When to use it: Use when the question asks whether a rating is investment or speculative grade, or which of several ratings is highest or lowest.

Memorise the line: BBB- / Baa3 is in, BB+ / Ba1 is out.
Convert Moody's names by letter: Baa is BBB, Ba is BB.
Rank by letter first, then by modifier (+ above plain above -; 1 above 2 above 3).
Eliminate options that mix up issue and issuer ratings.

Common mistakes in Credit Rating Agencies and Rating Scales

Treating BB+ or Ba1 as investment grade.
Students think the cut-off is at BB because it is the next letter after BBB.
Fix: The lowest investment grade is BBB- / Baa3. BB+ / Ba1 is already speculative.
Confusing Moody's Baa with Ba.
The names look similar.
Fix: Baa is the BBB category (investment grade); Ba is the BB category (speculative).
Mixing up issuer and issue ratings.
Both are described as the rating of a company's debt.
Fix: The issuer rating covers the borrower overall; the issue rating is for one instrument and reflects seniority, security and recovery.
Counting notches wrongly across categories.
Students forget that + and - modifiers are separate steps.
Fix: List the full scale: BBB+, BBB, BBB-, BB+, BB. From BBB to BB is three notches (BBB to BBB-, BBB- to BB+, BB+ to BB).
Saying a rating gives an exact default probability.
Default tables are linked to ratings, which suggests precision.
Fix: Ratings are ordinal opinions. Historical default rates by rating are separate empirical estimates.
Forgetting the issuer-pays conflict of interest.
Students focus only on the scale.
Fix: Note that issuers pay agencies, which raises conflict concerns that links to structured product failures.

Worked examples

Example 1

A portfolio manager holds bonds rated Baa2 (Moody's), BBB- (S&P), Ba1 (Moody's) and A- (Fitch). Which holding is speculative grade, and which bond is the lowest-rated of the investment grade holdings?

Show the solution

Convert to a common scale: Baa2 = BBB, BBB- = BBB-, Ba1 = BB+, A- = A-.
Apply the line: BBB- or better is investment grade. Ba1 (BB+) is below it, so speculative grade.
Rank the other three: A- > BBB > BBB-.
The lowest investment grade holding is the BBB- bond.

Answer: The Ba1 bond is speculative grade; the BBB- bond is the lowest-rated investment grade holding.

Example 2

Company X has an S&P issuer rating of BBB and is downgraded by one notch twice in succession. What is the rating after both downgrades, and is it investment grade?

Show the solution

Start: BBB. The first one-notch downgrade gives BBB-.
The second one-notch downgrade gives BB+ (the next step down).
BB+ is below BBB-, so it is speculative grade.

Answer: The rating after both downgrades is BB+ (BBB → BBB- → BB+), which is speculative grade.

Exam tips

Memorise the S&P to Moody's mapping table and the BBB- / Baa3 line; many questions reduce to this.
Read whether the question says issuer or issue rating before answering.
Count notches by writing out the ladder, especially across categories.
Watch for qualitative questions on issuer-pays conflicts and cliff effects when a bond drops to speculative grade.
Do not assume a rating equals a specific default probability unless a table is given.

Practice questions from External and Internal Credit Ratings

Credit Rating Agencies and Rating Scales in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Credit Rating Agencies and Rating Scales: frequently asked questions

What is the difference between investment grade and speculative grade?

Investment grade is BBB- or higher at S&P and Fitch, and Baa3 or higher at Moody's. Speculative grade is BB+ / Ba1 and below. Speculative grade bonds carry higher default risk and typically offer higher promised yields as compensation for that risk.

How do credit rating agencies assign ratings?

Analysts review financial ratios, business and industry risk, governance and country factors. A rating committee then votes on the rating. The rating is monitored and can be changed, placed on watch or given an outlook.

What is the difference between an issuer rating and an issue rating?

An issuer rating reflects the borrower's overall ability to pay. An issue rating applies to a specific debt instrument and also reflects seniority, security and expected recovery.

Do Moody's and S&P ratings use the same scale?

They use different symbols but similar tiers. Aaa matches AAA, Baa3 matches BBB-, and Ba1 matches BB+. Moody's uses numbers 1 to 3 as modifiers, while S&P and Fitch use + and -.