Guide to Analysing Companies

2 The degree of risk run by the lender. A blue-chip company
will be charged a much lower rate than a high-tech start-up with
no track record.
3 The demand for money. If the demand for money increases
because of faster economic growth, a central bank can
dampen demand by putting up interest rates (thus increasing
the cost of money).
Each country’s financial markets have their own key rate (or
rates) of interest. In the United States, the prime rate, the rate
at which commercial banks lend to their most creditworthy cus-
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tomers, is the central rate. This, in turn, is influenced by the
federal reserve, the US central bank, which acts to raise or
lower short-term interest rates.
Rate of return
A yardstick by which investors judge the merits of a security.
In the case of an ordinary share, the rate of return is the
annual dividend yield divided by the purchase price of the
share. For the total rate of return, include the capital gain (or
loss) since the share was purchased. For most fixed-income
securities, the rate of return is the coupon (or published rate
of interest) divided by the purchase price.
Rating
A classification of the quality of different financial instru-
ments and of the companies or organisations that issue them; an
assessment of the credit risk attached to the instrument – that
is, the chances that the interest and principal will not be
repaid as and when due. The international business of awarding
ratings is dominated by three big agencies: Standard & Poor’s,
Moody’s Investors Services and Fitch. Each has a slightly different
method for assessing the creditworthiness of the organisations
they rate, but all split ratings between investment grade and
non-investment grade (or junk). The higher the rating the cheaper
it is, by and large, for an issuer to raise money by issuing bonds
in the financial markets. Rating agencies have considerable clout.
By downgrading a company’s creditworthiness, an agency can
not only increase the cost of its capital but also, in some cases,
determine whether a troubled company survives or goes bust.