The Rating Agencies and Their Credit Ratings: What They Are, How They Work, and Why They are Relevant by Herwig Langohr, Patricia Langohr

The Rating Agencies and Their Credit Ratings: What They Are, How They Work, and Why They are Relevant by Herwig Langohr, Patricia Langohr
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The Rating Agencies and Their Credit Ratings:

What They Are, How They Work, and Why They are Relevant

by Herwig Langohr, Patricia Langohr


524 pages March 2009


Credit rating agencies play a critical role in capital markets, guiding the asset allocation of institutional investors as private capital moves freely around the world in search of the best trade-off between risk and return. However, they have also been strongly criticised for failing to spot the Asian crisis in the early 1990s, the Enron, WorldCom and Parmalat collapses in the early 2000s and finally for their ratings of subprime-related structured finance instruments and their role in the current financial crisis.

This book is a guide to ratings, the ratings industry and the mechanics and economics of obtaining a rating. It sheds light on the role that the agencies play in the international financial markets. It avoids the sensationalist approach often associated with studies of rating scandals and the financial crisis, and instead provides an objective and critical analysis of the business of ratings. The book will be of practical use to any individual who has to deal with ratings and the ratings industry in their day-to-day job.


"Rating agencies fulfil an important role in the capital markets, but given their power, they are frequently the object of criticism. Some of it is justified but most of it portrays a lack of understanding of their business. In their book The Rating Agencies and their Credit Ratings, Herwig and Patricia Langohr provide an excellent economic background to the role of rating agencies and also a thorough understanding of their business and the problems they face. I recommend this book to all those who have an interest in this somewhat arcane but extremely important area." -Robin Monro-Davies, Former CEO, Fitch Ratings.

"At a time of unprecedented public and political scrutiny of the effectiveness and indeed the basic business model of the Credit Rating industry, and heightened concerns regarding the transparency and accountability of the leading agencies, this book provides a commendably comprehensive overview, and should provide invaluable assistance in the ongoing debate." -Rupert Atkinson, Managing Director, Head of Credit Advisory Group, Morgan Stanley and member of the SIFMA Rating Agency Task Force

"The Langohrs have provided useful information in a field where one frequently finds only opinions or misconceptions. They supply a firm base from which to understand changes now underway. A well-read copy of this monograph should be close to the desk of every investor, issuer and financial regulator, legislator or commentator." -John Grout, Policy and Technical Director, The Association of Corporate Treasurers


Foreword Preface

1 Introduction

1.1 Context and Premises

1.2 Book Chapters

1.3 Supporting Materials


2 Credit Ratings

2.1 The World of Corporate Defaults

2.2 Credit Rating Scales

2.3 The Interpretation of Credit Ratings

2.4 Credit Ratings: Summary and Conclusions

3 The ¡®Raison d¡¯¨ºtre¡¯ of Credit Ratings and Their Market

3.1 Needs for Credit Ratings ¨C or the Demand Side of Ratings

3.2 Credit Ratings as a Solution to Information Asymmetry: Economic Analysis.

3.3 Credit Rating Segments ¨C or Scale and Scope of the Rated Universe.

4 How to Obtain and Maintain a Credit Rating

4.1 The Rating Preparation

4.2 The Rating

4.3 Quality of the Rating Process


5 The France Telecom Credit Rating Cycle

5.1 From Sovereign Status to Near Speculative Grade

5.2 Turning Point and Rating Recovery (Fall 2002¨CWinter 2004)

5.3 Analysis and Evaluation

6 Credit Rating Analysis

6.1 Fundamental Corporate Credit Ratings

6.2 Corporate Ratings Implied by Market Data

6.3 Special Sector Ratings

6.4 Technical Appendix

7 Credit Rating Performance

7.1 Relevance: Ratings and Value.

7.2 Preventing Surprise in Defaults: Rating Accuracy and Stability

7.3 Efficiency Enhancement: Stabilization in Times of Crisis


8 The Credit Rating Industry

8.1 The Rise of the Credit Rating Agencies

8.2 Industry Specifics and How they Affect Competition

8.3 Industry Performance

9 Regulatory Oversight of the Credit Rating Industry

9.1 The Regulatory Uses of Ratings

9.2 The Regulation of the Industry

9.3 Analysis and Evaluation

10 Summary and Conclusions

10.1 The Rating Agencies Value Added

10.2 The Challenges Rating Agencies Face Today

10.3 Concluding Thoughts




Herwig Langohr was Professor of Finance and Banking at Insead, in Fontainebleau, France, which he joined in 1976, specialising in corporate finance, financial services and corporate governance. He visited numerous academic institutions such as The Wharton School, The Darden School and the Universität Konstanz (Germany). He was holder of the Goldschmidt Chair in Corporate Governance at the Solvay Business School (Brussels). Professor Langohr served on several boards of directors, in particular on the Board of Directors and the Audit Committee of both the financial services group KBC Group N.V. and KBC Insurance N.V. He was Dean MBA and member of the Executive Committee at INSEAD from 1993-1995. He was also a frequent director of Executive Programs and a regular advisor in corporate finance and strategy in the banking sector. He was a contributor to academic journals such as The Journal of Monetary Economics, The Journal of Financial Economics and The Journal of Money, Credit and Banking; to numerous professional journals and newspapers and a regular publisher of case studies. He passed away at the age of 64 on May 28th 2008. Patricia Langohr is Professor of Economics at the Essec Business School, in Cergy, France, since 2005. Her research specializes in industrial organization, dynamic models of competition and the financial services industry. She teaches microeconomics, industrial organization and business economics. Prior to that, she was a researcher at the Price and Index Number Research division of the Bureau of Labor Statistics in Washington D.C. Professor Langohr obtained her PhD in Managerial Economics and Strategy from the Kellogg School of Management at Northwestern University in December 2003. She has a Diploma in Economics from the Humboldt Universität in Berlin and a Maîtrise in Monetary Economics and Banking from the Universit¨¦ Paris IX Dauphine.