Junk bonds, also known as speculative-grade bonds, are fixed-income securities issued by companies with lower credit ratings. These bonds tend to offer higher rates than other bonds to compensate investors for taking on more risk.
Junk bonds carry more risk compared to investment-grade bonds. The credit rating agencies assess the financial health and creditworthiness of companies that issue bonds, and lower ratings indicate a higher likelihood of default. Investors should carefully evaluate the credit rating and creditworthiness of the issuer before investing in junk bonds.
Investors are compensated for taking on the additional credit risk associated with junk bonds by receiving higher interest payments. The potential for higher returns is one of the primary attractions for investors who are willing to accept the greater risk.
The performance of junk bonds is influenced by market conditions and economic factors. During periods of economic stability and low default rates, junk bonds may perform relatively well and provide attractive returns. However, in times of economic downturn or financial stress, the risk of defaults increases, which can lead to a decline in the value of junk bonds.
Investing in junk bonds requires thorough research and due diligence to assess the risk-rward profile. Understanding the issuer's ability to meet interest payments and repay the principal is crucial to assess the risk-reward profile of the junk bond.
Junk bonds may have lower liquidity compared to investment-grade bonds. The market can be more volatile, and it may be more challenging to buy or sell these bonds quickly at desired prices. Investors should consider their investment horizon and liquidity needs first.