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High-Yield Bond

Candlefocus Editor
High-yield bonds, more commonly known as “junk bonds,” are fixed-income debt securities issued by corporations and higher-risk entities. These bonds pay higher interest rates than similar debt securities issued by companies that are judged to have very good creditworthiness by credit rating agencies such as Standard & Poor’s (S&P) and Fitch Ratings. In general, junk bonds have ratings of lower than BBB- from S&P and Fitch, or lower than Baa3 from Moody’s.

Due to their higher-risk nature, investments in junk bonds are likely to be rewarded with higher returns relative to other debt investments, such as those backed by particularly well-rated firms. However, the higher return potential is balanced with a higher likelihood of default. Companies with low credit ratings must pay higher interest rates to offset the increased default risk. Investors in junk bonds should be especially wary since the price of any security can swing widely in response to shifts in market sentiment.

Although investors in junk bonds do assume an additional risk, they can often enjoy high liquidity and strong diversification benefits from investing in higher-yielding securities. This has only been made more true in the years since the global financial crisis out of 2008. With longer-dated bonds in the Treasury market trading for very low yields, investors have looked for yield sources beyond the traditional markets. That has made junk bonds, a sometime forgotten asset class, become an attractive investment alternative.

In conclusion, investors should approach junk bonds with caution, keeping in mind the complexity that comes with investing in a higher-risk asset. Despite the higher risk, the higher yields they offer can be a highly attractive investment in the right environment. Investors must balance the advisory to invest in instruments with a strong credit rating with the potentially higher returns that come with lower-rated instruments. Nevertheless, junk bonds can be a useful tool for investors to make sure their portfolios meet their risk-return objectives.

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