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Introduction - Impact Of Changes In Credit Ratings On Equity Returns
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Relevance of the Proposed Research to Finance and/or Accounting
Credit rating is a process accessing the credit risk of any debt or financial instruments. It is mostly an instrument specific. Credit rating helps in reflecting the probability of timely payment of the principal and the interest, but does not tell us. Whether such instrument is overpriced or not (Wojewodzki et al. 2018). It is not a recommendation for investment as it depends on various factors such as rate of return, risk preferences, tax consideration. It is continuous process and helps in decision making to investors. Importance of credit rating for equity returns as it helps the investors to access the ranking of the default loss probability of a fixed income investment in comparison with the equivalent other rated investments in the market. As in the absence of such rating Individual have to analyze their own perception of risk and return.
Context of the study
As the market plays an immense faith on the credit rating as a result of which issuer may access markets at the time of adverse condition by high rated instruments. Moreover credit rating helps in determining an additional return to the investors, for the additional risk they bear. It can further say that higher the credit rating lower the risk of the investment and the vice versa.so we can conclude that there is a positive relation between the credit rating and the equity returns, as they are directly related to each other.
Justification of the chosen topic
The credit rating agency such as Standard & Poor, CRISIL, CARE, and other such agencies provide limitations and objectives of credit rating. As credit rating is an opinion of the future credit worthiness, which is being derived by fundamental analysis (Corhay, 2017). It is not any recommendation to buy or sell, it is only an opinion of the issuer’s credit policy. There is no such significant impact in the share price when there is rise in the credit rating, as that is being expected by the market, but there is a huge impact on the return when there is downward or negative credit rating being announced.
Value of this research
The main objective is to rate the quality of debenture, bonds, deposits, as the various rating directly or indirectly helps the investors to understand the potential of the risk of debt in the company. They help in boosting confidence and decision making to the investors.
Significance and purpose
Credit rating helps in publishing the vital information, which helps in the accuracy, timely manner valuation. Credit rating plays an important role for both bond and equity market as they give support in decision making for the investors, by regular reviewing the ratings provide an easy way of understanding , and saving time and effort of the investors. It further helps in building corporate image and greater avenue of borrowings to the issuers. Further credit rating helps in transparency. Reducing dependency and creating differentiation between company by timely action and updates.
Credit rating agencies act as a certification role, as they are formed by professional who are skilled, experienced, trained and they form knowledge in order to make risk related opinions. Many regulators or the investors requires in order to decision making or approval or confirmation approval. Hence it effects in equity return to a greater extent as they guide in making a decision towards the investments by the investors.
There is a direct relationship between credit ratings and the equity returns as the higher the credit rating, higher will be the return and lower the credit rating, lower the returns .hence credit rating and equity return goes hand in hand, they are directly related to each other. The higher the rating, lower the probability of the default, which leads to higher investment by the investors.
Research Question and Research Objectives
What effect does credit rating changes have on equity return?
- To provide theoretical concept of credit ratings and equity returns.
- To analyze extent to which credit ratings can affect to equity returns.
- To assess role of credit ratings for bond and equity markets.
- Explain how your proposal relates to the academic debate which has been identified as part of the literature review
Credit ratings are the prediction of probability of default. Further hitcher noted that credit rating is probably a proxy for the like hood of nay default (Hilscher and Wilson, 2017). It reflects only systematic default risks. It further captured the investor’s aspects of credit risk leading to two attributes as systematic default of risk and probability of raw default. His further emphasis that the use of the credit rating as proxy does not only reduces the times of the observations but also does not emphasis on the dynamic nature of a behavior of the firm. The information in the credit rating agencies may not be audited as a result they do not recommend anything to buy, hold or sell it, but it helps in gaining confidence and building foreign collaboration in a simplified manner.
- Demonstrate a link between previous work and current work that has been done in your field of research interest
The return on investment in equity return in the words of (Ang and Phalippou, 2018) is that the private equity funds investments are required to be done in a fair market value. It helps in improving the performance of the business in order to achieve the goal of an organization and to sustain in the long run.
Hilscher, J. and Wilson, M., 2017. Credit ratings and credit risk: Is one measure enough?. Management science, 63(10), pp.3414-3437.
Ang, A., Chen, B., Goetzmann, W.N. and Phalippou, L., 2018. Estimating private equity returns from limited partner cash flows. The Journal of Finance, 73(4), pp.1751-1783.
Wojewodzki, M., Poon, W.P. and Shen, J., 2018. The role of credit ratings on capital structure and its speed of adjustment: An international study. The European Journal of Finance, 24(9), pp.735-760.
Corhay, A., 2017. Industry competition, credit spreads, and levered equity returns. Rotman School of Management working paper, (2981793).