{"id":3495,"date":"2019-09-06T12:00:00","date_gmt":"2019-09-06T12:00:00","guid":{"rendered":"https:\/\/analystprep.com\/cfa-level-1-exam\/?p=3495"},"modified":"2026-03-11T16:14:58","modified_gmt":"2026-03-11T16:14:58","slug":"risks-relying-ratings-credit-rating-agencies","status":"publish","type":"post","link":"https:\/\/analystprep.com\/cfa-level-1-exam\/fixed-income\/risks-relying-ratings-credit-rating-agencies\/","title":{"rendered":"Risks in Relying on Ratings from Credit Rating Agencies"},"content":{"rendered":"\n<script type=\"application\/ld+json\">\n{\n  \"@context\": \"https:\/\/schema.org\",\n  \"@type\": \"QAPage\",\n  \"mainEntity\": {\n    \"@type\": \"Question\",\n    \"name\": \"Which option is least likely to be a limitation of credit rating agency ratings?\",\n    \"text\": \"Which of the following is least likely a limitation of relying on credit rating agency ratings?\\n\\nA. Some risks are very hard to identify.\\nB. Credit ratings tend to lag the market pricing.\\nC. Credit ratings have historically been quite inaccurate.\",\n    \"answerCount\": 1,\n    \"acceptedAnswer\": {\n      \"@type\": \"Answer\",\n      \"text\": \"The correct answer is C. Credit rating agencies have generally been reasonably accurate in assessing default risk. Common limitations include that ratings can change over time, they tend to lag market pricing, some risks are difficult to capture, and rating agencies can occasionally make mistakes.\"\n    }\n  }\n}\n<\/script>\n<script type=\"application\/ld+json\">\n{\n  \"@context\": \"https:\/\/schema.org\",\n  \"@type\": \"VideoObject\",\n  \"name\": \"Fundamentals of Credit Analysis (2025 Level I CFA\u00ae Exam \u2013 Fixed Income \u2013 Module 6)\",\n  \"description\": \"This video lesson covers credit risk in corporate bonds, including default probability, loss severity, and seniority rankings. It explains issuer and issue credit ratings, the role of notching, and limitations of relying on rating agencies. The lesson also explores credit analysis using financial ratios, the four Cs, yield spread influences, and high-yield\/sovereign debt considerations.\",\n  \"uploadDate\": \"2022-06-02T00:00:00+00:00\",\n  \"thumbnailUrl\": \"https:\/\/i.ytimg.com\/vi\/zSl9z7qQB00\/hqdefault.jpg\",\n  \"contentUrl\": \"https:\/\/www.youtube.com\/watch?v=zSl9z7qQB00\",\n  \"embedUrl\": \"https:\/\/www.youtube.com\/embed\/zSl9z7qQB00\",\n  \"duration\": \"PT41M06S\"\n}\n<\/script>\n\n\n\n<iframe loading=\"lazy\" width=\"560\" height=\"315\" src=\"https:\/\/www.youtube.com\/embed\/zSl9z7qQB00?si=YQIk0w46fX9pOGWT\" title=\"YouTube video player\" frameborder=\"0\" allow=\"accelerometer; autoplay; clipboard-write; encrypted-media; gyroscope; picture-in-picture; web-share\" referrerpolicy=\"strict-origin-when-cross-origin\" allowfullscreen><\/iframe>\n\n\n<p>Investors overwhelmingly believe that credit rating agencies do a good job assessing credit risk. In fact, with a few exceptions (e.g., too high ratings on US subprime mortgage-backed securities issued in the mid-2000s that turned out to be much riskier than expected), their ratings have proved to be quite accurate in the measurement of default risk.<\/p>\n<p>The highest-rated bonds have extremely low default rates. On the other hand, the lower the rating, the higher the annual rate of default. Bonds rated CCC have a 20% chance of default each year, while bonds rated BBB have a default probability of only 0.18%.<\/p>\n<h2><strong>Limitations of Rating Agencies<\/strong><\/h2>\n<p>The following are the limitations and risks to relying on credit rating agency ratings:<\/p>\n<h3><strong>Credit ratings can change over time<\/strong><\/h3>\n<p>Over a long time, credit ratings can shift. A bond with a BBB with only a 0.18% probability of default could be downgraded to CCC and, therefore, have a 20% chance of default. However, the higher the credit rating, the higher the rating stability, meaning there is a lower probability that the bond\u2019s rating will shift.<\/p>\n<p>Creditworthiness fluctuates over time. Bond investors should, therefore, not assume that credit rating will remain constant throughout the entire holding period.<\/p>\n<h3><strong>Credit ratings tend to lag the market pricing of credit risk<\/strong><\/h3>\n<p>Bond prices and spreads frequently move more swiftly than rating agencies change their ratings. Bond prices could move down sharply well before a rating agency downgrades its credit rating.<\/p>\n<h3><strong>Rating agencies may make mistakes<\/strong><\/h3>\n<p>Examples include mis-ratings of US companies, Enron and WorldCom, and European issuer, Parmalat. In these instances, rating agencies could not see the accounting fraud.<\/p>\n<h3><strong>Some risks are difficult to capture<\/strong><\/h3>\n<p>Litigation risks, for instance, may affect tobacco or energy, or chemical companies. Also, some unpredictable events such as earthquakes or tsunamis may have severe effects on credit quality.<\/p>\n<blockquote>\n<h2><strong>Question<\/strong><\/h2>\n<p>Which of the following is <em>least likely<\/em> a limitation of relying on credit rating agency ratings?<\/p>\n<ol style=\"list-style-type: upper-alpha;\">\n<li data-tadv-p=\"keep\">Some risks are very hard to identify.<\/li>\n<li data-tadv-p=\"keep\">Credit ratings tend to lag the market pricing.<\/li>\n<li data-tadv-p=\"keep\">Credit ratings have historically been quite inaccurate.<\/li>\n<\/ol>\n<p><strong>Solution<\/strong><\/p>\n<p>The correct answer is <strong>C<\/strong>.<\/p>\n<p>Investors overwhelmingly believe that credit rating agencies do a good job assessing credit risk. In fact, with a few exceptions, their ratings have proved to be quite accurate in the measurement of default risk.<\/p>\n<p>There are 4 major limitations:<\/p>\n<ul>\n<li>credit ratings are can change over time;<\/li>\n<li>credit ratings tend to lag the market (Option B);<\/li>\n<li>rating agencies make mistakes; and<\/li>\n<li>some risks are hard to capture (Option A).<\/li>\n<\/ul>\n<\/blockquote>","protected":false},"excerpt":{"rendered":"<p>Investors overwhelmingly believe that credit rating agencies do a good job assessing credit risk. In fact, with a few exceptions (e.g., too high ratings on US subprime mortgage-backed securities issued in the mid-2000s that turned out to be much riskier&#8230;<\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[9],"tags":[],"class_list":["post-3495","post","type-post","status-publish","format-standard","hentry","category-fixed-income","blog-post","no-post-thumbnail","animate"],"acf":[],"yoast_head":"<!-- This site is optimized with the Yoast SEO plugin v26.9 - https:\/\/yoast.com\/product\/yoast-seo-wordpress\/ -->\n<title>Risks of Credit Rating Agency Ratings | CFA Level 1<\/title>\n<meta name=\"description\" content=\"Explore the limitations of credit rating agencies, including default risk misjudgment, delayed updates, and reliance on historical data in bond ratings.\" \/>\n<meta name=\"robots\" content=\"index, follow, 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