Junk Bond

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Related to Junk bonds: High yield bonds

Junk Bond

A security issued by a corporation that is considered to offer a high risk to bondholders.

Junk bond is the popular name for high-risk bonds offered by corporations. A bond is a certificate or some other evidence of a debt. In the world of corporate finance, a corporation may sell a bond in exchange for cash. The bond contains a promise to repay its purchaser at a certain rate of return, called a yield. A bond is not an Equity investment in the corporation; it is debt of the corporation.

A corporate bond is essentially a loan to a corporation. The loan may be secured by a lien or mortgage on the corporation's property as security for repayment.

To determine the level of the default risk for potential bondholders, financial experts analyze corporations and rate them on a number of factors, including the nature of their business, their financial holdings, their employees, and the length of their existence. The higher the risk for bondholders, the lower the risk rating given the corporation.

Because their ventures are considered risky, low-rated corporations must offer bond yields that are higher than those of high-rated corporations. High-rated corporations have less need for income from bonds, so they do not need to offer high yields. Bonds from these companies are called investment-grade bonds. Low-rated corporations have the need for bond income, so they offer high-yield bonds. These high-yield bonds are junk bonds.

When a corporation fails, bondholders may lose all or part of their investment if the corporation has declared Bankruptcy or has no assets. This possibility is more real for junk bonds because they are, by definition, issued by unproven or unhealthy corporations.

For some persons, the high yield of a junk bond can be worth the increased risk of default. Junk bonds can increase in value if the corporation's rating is upgraded by private bond-rating firms. Junk bonds are also favored by some persons precisely because they contribute capital to young or struggling corporations. Whether to buy a junk bond depends on the investor: conservative investors do not favor them, but speculators and others seeking a quick profit find them attractive.

Further readings

Boyer, Allen. 1989. "For the Love of Money." Georgia Law Review 23.

References in periodicals archive ?
Junk bond issuance in the fourth quarter fell to $13 billion from $30 billion in the third quarter and around $18 billion in the fourth quarter of last year, making it the weakest quarterly performance since 2011, said Firth.
Therefore, if money market interest rates are zero, and junk bonds now also trade at close to zero, the risk premium has become compressed, has become very small, insufficient to compensate the investor when a correction happens.
But greater return also means greater risk, especially with junk bonds, where the risk of default is relatively high.
Best suited to investors who tolerate risk and hold long term, junk bonds should constitute just a portion of an overall bond portfolio.
Moreover, the most speculative segment of the industry's junk bond holdings - Classes 5 and 6 - rose to record levels.
Proposes to sell most, if not all, of First Capital's risky junk bond portfolio in a timely and orderly manner;
He recommends that even aggressive investors put no more than 5 percent of their money into junk bonds these days.
these entities to make investments in junk bonds that were unsuitable
At the same time, junk bonds, one of the industry's favorite vehicles for generating more yield in this environment, have exposed insurers to increasing defaults.
1 billion in junk bonds - or bonds with ratings below investment grade - issued by RJR Holdings as part of its leveraged buyout in 1989.
55 billion, primarily through a $250 million increase in the price being paid for ELIC's junk bonds.
The research demonstrates," said Chau, "this investment approach will add equity market risk and return, if the corporate bonds invested are rated as junk bonds.