Table of Contents
What are junk bonds and how do they work?
Like any bond, a junk bond is an investment in debt. A company or a government raises a sum of money by issuing IOUs stating the amount it is borrowing (the principal), the date it will return your money (maturity date), and the interest rate (coupon) it will pay you on the borrowed money.
Can you make money with junk bonds?
Now that we have a basic understanding of junk bonds, how can regular investors profit from them? Junk bonds are a great addition to your portfolio, rather than a singular investment. They can add diversification and long-term income, but are simply too risky to have much exposure with your capital.
What are junk bond funds?
Funds that hold high-yield bonds – sometimes called “junk” bonds – offer investors greater yield in exchange for greater risk. That’s because the bonds sold by these debt issuers aren’t investment-grade, and there is a greater chance of default.
Why would someone buy a junk bond?
Junk bonds represent bonds issued by companies that are financially struggling and have a high risk of defaulting or not paying their interest payments or repaying the principal to investors. Junk bonds are also called high-yield bonds since the higher yield is needed to help offset any risk of default.
Why would a person invest in a junk bond?
Junk bonds have the potential of significant price increases should the company’s financial situation improve. Junk bonds serve as a risk indicator of when investors are willing to take on risk or avoid risk in the market.
How often do junk bonds default?
The BB-rated bonds seem to default at about 2\% per year, on average, and the B-rated bonds at about 4\% per year. Of course, rates can temporarily be much higher: even 8\% to 10\% per year at times for B-rated debt. Remember, default does not mean total loss though; about 40\% of defaulted debt is eventually recovered.
How much do junk bonds cost?
Junk bonds have higher default rates. According to S&P Global Ratings, the default rate for junk bonds was 5.5\% in 2020. By contrast, the default rate for investment-grade bonds is 0.00\%.
Who can issue junk bonds?
A bond that has a high risk of the underlying company defaulting is called a junk bond. Companies that issue junk bonds are typically start-ups or companies that are struggling financially. Junk bonds carry risk since investors are unsure whether they’ll be repaid their principal and earn regular interest payments.