Credit quality measures the likelihood of an issuer repaying its debts. Judgments about a firm's ability to pay its debts are encapsulated in a credit rating. Credit rating firms, such as Moody's and Standard & Poor's, closely examine a firm's financial statements and assign a letter grade to the company's debt: AAA indicates the highest credit quality and D indicates the lowest. All other things being equal, the lower a bond's credit quality, the higher its yield. Because higher-grade issuers are more likely to meet their obligations, investors trade greater certainty for higher income. Credit quality affects more than just a bond's yield, though; it can also affect its performance. High-yield bond funds usually take a hit when investors are worried about the economy, as recessions usually mean lower corporate profits and thus less money to pay bondholders.
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