Updated on March 3, 2023
Junk bond is a highly speculative grade bond, which comes with high return but with a very high risk of default as well. Buying a bond means lending money to the issuer. Bonds are issued by companies, governments, institutions or entities which quote an interest rate while issuing the bonds and a promise to return the investment along with the interest after the stipulated time frame. Interest can be paid separately at regular intervals or together with the initial investment. A bond is issued at Face Value and comes with a tenure and a coupon rate. Bond prices are dependent on certain factors like rate, maturity and issuer’s credit rating. Not all bonds keep their promise of repaying principal with interest at maturity and thus pose greater risk of default. Such Bonds issued by companies which do not have the capability to return investor’s money are called Junk Bonds. If a company with good cash flows today turns into losses in future and is unable to pay back the principal and interest, its bonds will become Junk Bonds.
How to identify Junk Bonds?
It is important to identify bonds for their quality, before investing. Some key parameters to identify Junk bonds are:
1. These are issued by companies which are not financially strong
2. Credit rating of the Junk bond issuer is poor or below investment grade
3. Interest rates offered are comparatively high to attract investors
4. Junk Bonds come with a ‘BB-’, ‘C’ or ‘D’ (Default) rating