What Is a Junk Bond?

What Is a Junk Bond?

By Charles Joseph | Editor, Financial Affairs
Reviewed by Corey Michael | Senior Financial Analyst

A junk bond is a type of bond that carries a higher risk of default than most bonds issued by corporations. These bonds are also referred to as high-yield bonds because they offer higher interest rates to compensate investors for the risk they’re taking. Essentially, junk bonds are rated below investment grade by the major credit rating agencies, which means they are considered to be speculative and carry a higher level of risk. They’re often issued by companies who have poor credit ratings, possibly as a result of financial difficulties or high amounts of debt.

Related Questions

1. Why would an investor choose a junk bond over a safer option?

Some investors might choose a junk bond over a safer option because of the potential for higher returns. Despite the higher risk of default, the significant yields that can come from junk bonds can make them attractive for investors who are willing to take on more risk for more reward.

2. Are all junk bonds high risk?

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While junk bonds are generally considered high-risk investments, they’re not all created equal. Some may be only slightly riskier than investment-grade bonds, while others may be highly speculative. It’s important for investors to thoroughly research any potential investments to understand the risks involved.

3. How are junk bond ratings determined?

Major credit rating agencies like Standard & Poor’s, Moody’s, and Fitch assign ratings to different bonds. Anything rated ‘BB’ or lower by S&P and Fitch or ‘Ba’ and below by Moody’s is considered non-investment grade, or a junk bond. These ratings are based on an assessment of the issuer’s ability to pay back the debt.

4. Can you lose your investment with a junk bond?

Yes, there is the potential to lose your investment with a junk bond. Companies that issue this type of bond have a higher risk of defaulting on their debt, which could result in significant financial loss for investors.

5. Are junk bonds taxable?

Like most bonds, junk bonds do generate income that is taxable. The interest you earn from a junk bond is typically taxed at your ordinary income tax rate. However, if the bond is in a tax-advantaged account like an IRA, taxes may be deferred.