By: Julio Perez, Spring 2018 IAC Graduate Research Assistant
Finally, an investment concept with two names that both tell you pretty much everything you need to know about the security.
A “junk” bond name is given due to low bond rating which gives it its high risk status, given to it by a Nationally Recognized Statistical Rating Organization (such as Moody’s Investors Services or Standard & Poor’s Corporation) with a corresponding symbol indicating its high risk.
With higher risk come some new and unfamiliar terms, such as “default.” We have already discussed taking out bonds with the government or banks, which give you low interest bonds because the investor knows the entity will make good on their bonds. Bonds with default risk, however, have a risk that the company will fail to make timely interest payments, or default on the bond completely. This high risk is also why said junk bonds tend to have very high interest rates, to entice investors who would not otherwise invest in such risky securities.
In addition to teaching us about a new type of risk, junk bonds try to cram in every other type of risk, too. Junk bonds also have high liquidity risks, making it harder for a seller to find the price he wants to his bond.
For information on how the risk of high-yield bonds, check out this SEC Investor Bulletin.
Translated: “I just want to invest in the riskiest bond out there, and I’m prepared to lose everything.”