The credit rating impact on bond yield, borrowing cost and firm value.

Abstract

Credit ratings and investment grades constitute a potential source of information for market participants: they are able to assess the creditworthiness of borrowers. Investors purchase these ratings to find their answers on the quality of the bond and thus rely heavily on these opinions in their investment decisions. Previous literature has shown that bond rating revisions and new announcements can trigger market reaction and are accompanied by an increase in the cost of borrowing of borrowers. Firms might be unable to raise the required sources of funds to finance new NPV projects. In addition, they incur higher costs of debts as investors ask for higher yield to compensate them for the higher default risk. In this project, I will try to identify the potential impact of credit rating on firm value using these two approaches. In this project, I will start by a general introduction, to define and explain next in Chapter 2 the credit ratings agencies and the importance of their regulatory power. Then, in Chapter 3, I will cover the literature review on the various effects of credit rating to securities prices, borrowing cost, capital structure, which will be followed by a review on the main determinants of firm value. Chapter 4 elaborates the model that explains the possible impact of credit rating on borrowing cost and firm value. Chapter 5 presents case studies followed by model’s limitations in Chapter 6 to a general conclusion in Chapter 7.