Many companies require financing either to handle day to day operations, or to finance large projects. Either way, that financing often comes in the form of issuing bonds. These bonds are then repaid over time. However, investors can lose their entire investment should the bonds not be repaid. Rating agencies analyze the bonds and their companies and rate them. These ratings can be used to help determine risk.
A rating of BBB represents the lowest investment grade bond rating. All ratings below BBB are considered to be "junk bonds" or high yield bonds.
A credit rating helps an investor determine the risk associated with a particular bond. A BBB rating means that the bond still is considered an investment grade bond, though it does carry more risk than higher rated bonds. Thus, an investor may choose whether it is worth the risk to get a higher rate of interest.
Ratings are not set in stone. Ratings are set by various rating agencies. Many people are not aware that there is more than one rating agency, and thus more than one rating for certain bonds. Additionally, each rating agency has its own grading scale. Thus, BBB is a generic term used to describe a rating agency's lowest investment grade rating.
BBB bonds provide a potentially higher rate of return for an investor that higher rated bonds, while still providing some measure of security. A BBB rating means that a company is not considered likely to default on the bonds or enter bankruptcy by the rating agency. However, there is a higher risk associated with BBB than higher ratings, so the interest payment will be higher. BBB bonds may make for a good way to get extra income as part of a diversified portfolio.
Although a BBB rating is an investment grade rating, it is the lowest possible investment rating. Thus, a single downgrade will turn the bond into a junk bond and thus may adversely affect its price. Rating agencies occasionally will publish a notice that essentially says that they are leaning one way or another regarding upgrades or downgrades. These notices often have only a small effect on a bond's price. However, in the case of a BBB rated bond, a downgrade leaning can have a large effect because if the downgrade were to happen, the bond would lose its investment grade status.
Many investment entities are prohibited from investing in junk bonds, or bonds rated below BBB. Thus, a downgrade below BBB can cause a lot of volatility following the downgrade, as those firms must sell the bonds in order to comply with their rules. A buying opportunity can exist in this environment if bonds are carefully selected by a skilled investor who thinks the downgrade may either be temporary, or that the bonds will withstand the downgrade after the short-term tempest.