A junk bond is one of the types of corporate bonds. It offers both high risk and high return. Yet, these bonds have been rated as not investment grade by Moody’s and Standard & Poor’s. The reason behind that is because the companies which usually issue these bonds are not fiscally sound.
If we compare investing in junk bond to another kind of bonds, junk bond offers the highest return. That is why many people also refer to this bond as high yield bonds.
If you invest in junk bond, you will get an early indication of the amount of capital you want to risk. If investors walk out of the junk bonds, then they do not feel optimistic about the economy. On the other hand, if there are people buy this bond, then they are confident about the economy as they are willing to take more risk.
The Ratings of Junk Bonds
Standard &Poor’s as well as Moody’s rate these bonds as speculative. That means the company has high probability to face default. Besides, these companies also highly exposed to bad economy and bad economy or business condition.
Investors usually classify junks bonds as either ‘Fallen Angel’ or ‘Rising Star.’ It is a fallen angel if the bonds were previously investment grade. Usually, this company has a worsening credit, until the credit agency lowers its rating.
Meanwhile, the rising start bonds are those with improved credit whose rating was raised.
The Advantages of Investing in Junk Bonds
The biggest advantage that comes from the junk-bond investment is it boosts the overall return in your portfolio. Besides, it also helps you avoid the volatility of stocks. It offers a higher yield than the investment-grade bonds. Junk bonds also give you the opportunity to make a better profit once there is an upgraded if the business improves.
It gives a fixed interest payment and also highly correlated to the stock market. Thus, in case of bankruptcy, the bondholder will get the payment ahead of the stockholders.
Other than those, junk bonds have a 10 years term or less and can be called after four to five years. During the expansion phase of a company, usually, junk bond performs their best.
The Disadvantages of Investing in Junk Bonds
Once the company experiences default, then you lose all of your initial investment. To avoid that, you need to thoroughly evaluate the company creditworthy.
Junk bonds are also vulnerable to interest rates increases. That is because banks will have lesser intention to lend them money, once the yield curve flattens.
Writer: Lisa Ramadhani
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