Junk Bond
Candlefocus EditorA junk bond, also known as a high-yield bond or non-investment grade bond, is debt that has been given a low credit rating by a credit rating agency, usually below the BB or B rating. These bonds are typically issued by companies that do not have strong financial standing and pose a higher risk than other bonds, as the issuer of the bond is more likely to default on the loan or experience a credit event. As a result, these bonds are typically issued with a higher interest rate to compensate for the higher risk associated with them.
Investors who purchase junk bonds take on a much greater risk than those who purchase investment grade bonds, as the default rate of a lower-rated bond is significantly higher than that of a higher-rated bond. Moreover, a junk bond’s value is much more volatile than that of other bonds, so it is important to remember that the price of the bond can fluctuate dramatically over time. Consequently, junk bonds should only be purchased by investors who understand the extra risk involved, as well as the potential for significant reward.
Junk bonds are usually priced at a discount to reflect the higher risk and unpredictable nature of the bond. For example, if the market prices for an investment grade bond with a similar amount of remaining time until maturity are at a price of 93, then a junk bond with the same amount of remaining time until maturity may be priced at 80 to 85. This discount in price is what allows investors to buy junk bonds that offer a higher yield than similar investment grade bonds.
Additionally, junk bonds offer investors the potential to achieve much higher returns than those available from most traditional investments, such as certificates of deposit (CDs) and treasury bonds. It is important to bear in mind, however, that although junk bonds can offer higher returns, they also pose a much higher risk of default and price volatility. Consequently, these bonds should only be purchased by investors who understand the associated risks and have conducted their own individual due diligence on the issuer prior to purchase.
In conclusion, a junk bond is a type of debt instrument with a lower credit rating than investment grade bonds. Although these bonds are riskier than investment grade bonds, they can offer investors the potential to achieve higher returns if managed correctly. However, it is essential for investors to understand the risks of default and price volatility that are associated with investing in junk bonds prior to purchase.