A junk bond, also known as a high-yield bond, is a type of corporate bond that is considered to have a higher risk of default compared to investment-grade bonds. These bonds are typically issued by companies with lower credit ratings or a less stable financial position. The term “junk” reflects the higher risk associated with these bonds.
Investment-grade bonds are bonds issued by companies or governments with strong creditworthiness, meaning they are less likely to default on their debt payments. In contrast, junk bonds are issued by companies that may have a history of financial difficulties, higher debt levels, or lower credit ratings from credit rating agencies.
Because of the higher risk involved, junk bonds offer investors higher interest rates or yields as compensation for taking on the added risk. Investors who are willing to accept this risk may be attracted to junk bonds as they can potentially provide higher returns. However, the trade-off is that there is a greater chance of the issuer failing to make interest payments or repay the principal when the bond matures.
Investors in junk bonds should carefully assess the financial health of the issuer and consider their risk tolerance before investing, as the potential for higher returns comes with a higher level of risk.