A junk bond is exactly the same as a regular bond. Junk bonds are an I.O.U from a corporation or organisation that states the amount it will pay you back (principal), the date it will pay you back (maturity date) and the interest (coupon) it will pay you on the borrowed money.
Junk bonds differ because of the credit quality of their issuers. All bonds are characterised according to this credit quality and therefore fall into one of two categories of bonds:
- Investment Grade - these are bonds issued by low- to medium-risk lenders.
- Junk Bonds - these are the bonds that pay high yields to bondholders because the borrowers don't have any other option. Their credit ratings are less than pristine, making it difficult for them to acquire capital at an inexpensive cost.
Although junk bonds pay high yields, they also carry higher-than-average risk that the company will default on the bond.
With this type of bond, you risk the chance that you will never get your money back. Secondly, investing in junk bonds requires a high degree of analytical skills, particularly knowledge of specialised credit.
Despite their name, junk bonds can be valuable investments for informed investors. If you would like to find out more about junk bonds as part of your wider portfolio, please talk to a qualified Holborn Assets adviser today.