A Junk Bond is a colloquial term for a high-yield or non-investment grade bond. Junk bonds are fixed-income instruments that carry a rating of BB or lower by Standard & Poor’s, or “Ba” or below by Moody’s. Junk bonds are so called because of their higher default risk in relation to investment grade bonds.
Bonds that have a high credit rating are known as investment-grade bonds. Bonds that are likely to default are called speculative or non-investment grade. Low-grade bonds may be issued by companies without long track records, or with questionable ability to meet their debt obligations. Because most brokers do not invest in these low-grade bonds, they are known as junk bonds. However because of the very high interest rates these bond issues typically offer, they are also referred to as high-yield bonds.
Because junk bonds have a high default risk, they are speculative. Default risk is the chance that a company or government will be unable to pay its obligations when the bonds mature. Defaults on bonds most often occur within the first several years of a bonds issue.
Even when a junk bond defaults, it might still keep some of its value. The impact of a default on a bond’s price is known as its default loss rate. Sometimes a bonds actual price loss is not the same as its rate of default loss. A default due to bankruptcy will probably reduce a bond’s price more than a default due to a company changing its strategic direction.
Bonds with AAA rating are least likely to default, and bonds with “D” rating is assigned for bonds that default. Junk bonds usually have a rating of BB or lower. If the company’s financial performance improves, the credit rating may increase, which increases the price of the junk bond. Junk bonds will have much larger price swings than bonds of higher quality.
Junk bonds are frequently unsecured or partially secured, and they pay higher interest rates than blue chip corporate bonds of comparable maturity period.
