What Is a Junk Bond?
Junk Bond Definition
A junk bond is a bond that carries a high risk of default, or a high risk that the issuing company will not be financially able to pay back its investors.
These could be issued by small start-ups as well as larger companies that are struggling financially.
To compensate for the increased risk to investors, these bonds also usually offer higher interest payments.
Because of this they are sometimes referred to as “high-yield bonds.”
Buying Junk Bonds
While buying junk bonds is significantly more risky for investors than buying historically safe bonds (so called “investment grade bonds”), if the issuing company’s financial state improves, investors stand to see good returns.
The interest rate on a bond, also called its coupon rate, doesn’t change once issued.
If a company issues a junk bond with, say, a 15% coupon rate while the prevailing rate is 5%, and the company survives, then an investor holds a significantly valuable bond.
Junk Bond Interest Rates
Investors who buy junk bonds don’t always do so just for the interest payments.
If the issuing company is financially sound, high coupon rate bonds can be sold for well above the price originally paid.