Glossary
Junk Bond
Low-rated bonds that pay high interest
Junk bonds are issued by companies rated below investment grade. Also called high-yield bonds, they pay more interest in exchange for greater risk.
The threshold is generally below BBB-. Issuers include companies with strained finances, businesses in difficulty, and firms taken over using heavy borrowing.
The high yield exists because defaults genuinely happen. In good times almost none occur and returns look excellent, but recessions bring defaults all at once.
That gives them equity-like behaviour. The word bond invites the assumption of safety, yet in a downturn their prices fall while government bonds rise.
If you hold them, a diversified fund is safer than individual issues. A single default causes serious loss, so exposure across dozens of issuers is what makes the average work. A narrow credit spread means the market is pricing risk lightly. At such times it is worth asking whether the extra interest genuinely compensates the risk being taken.