Bonds are a type of investment that allows a corporation or government to raise money while offering a fixed return for the investor. The investor buys a bond (lends money to a corporation or institution) and the government or corporation is then obliged to pay the investor back their money at a set time including a set level of interest. Bonds may also be issued by governments during times of war to raise money to grow and maintain military forces. There are many different types of bonds however the financial conditions are similar. Bonds almost always have a set maturity date when the lender is paid back the money together with a set interest rate during the lifetime of the bond. Most bonds are considered to be a safe, secure investment with a guaranteed return.
What are Junk Bonds?
Junk bonds, which are also known as high-yield bonds, non-investment grade bonds and speculative bonds, are a type of bond that has a high risk of default attached to them. This means that the corporation or institution that is issuing the bond may be unable to pay back the money it has borrowed. These types of bonds are rated below investment grade and are riskier than investment grade bonds. Investment grade bonds are bonds issued by corporations or institutions, such as the US Treasury, that are highly likely to be able to pay out the bond in full. Junk bonds will usually pay higher interest rates to attract potential investors because of the risky nature of the investment. Junk bonds are usually purchased in the hopes that the corporation or institution will do well financially and deliver a huge payout to the investor when bonds are paid out. The companies that issue these types of bonds do not have the credit quality to achieve investment grade ratings.
Junk bonds are usually issued by two types of corporations or institutions, sometimes known as fallen angels or rising stars. Fallen angels are junk bonds that used to meet investment grade, but for some reason the corporation or institution has suffered a hit to its credit rating. A rising star is a junk bond that’s rating is increasing due to the corporation or institution improving its credit quality. This type of bond is considered to be on its way to becoming an investment grade bond.