Junk Bond Definition

Junk Bond Definition​

         A bond or Debenture will payoff the investor a return in the form of interest. But there is another type of bond, which is the junk bond, which pays extraordinarily high interest rates because of its high risk of default.


Why is it called a junk bond?

          Bonds are rated according to the credit rating of the borrower In the United States, the main rating agencies are Fitch, Standard & Poor’s, and Moody’s. The descending order of value format is AAA, AA, A, BBB, BB, B, CCC, CC, C, D. Anything rated BB or lower is considered a junk bond because of its good credit risk.

Restrictions on Junk Bonds

         In some cases, investors may be prohibited from investing. As a rule, the objective of the fund or the owner of the fund. For example, retirement pension funds of companies or governments that prohibit the purchase of bonds that are rated lower than A or BB. This makes the junk bond market more restrictive than the market for high-rated bonds, commonly known as “investment grade bonds,” because even though they have high returns, they come at the expense of high risk as well.

         Which is the purpose of the majority of people who buy bonds: to reduce the risk and get a definite return, even if it is lower than stocks. The use of junk bonds is widespread in all sectors of businesses that require large amounts of capital to run their businesses. 

        Specifically, the telecommunications and energy sectors are two industries that are widely used in junk bonds because they give high returns. But the risks are high as well. Recently, a number of companies have been found to be dealing with debt by deliberately recording false financial information to help get a higher credit rating in order to upgrade their credit rating to investment grade bonds.

         However, if the bond purchase is to reduce the risk and it definitely pays off. Junk Bond was an inappropriate choice. But if investors are able to take risks for higher returns, junk bonds may be one investment option.

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