What Are Junk Bonds?

Junk bonds can boost an investor's portfolio, given the immense growth potential they hold.

Junk bonds are a form of fixed income security that is rated below investment grade by one or more rating agencies due to the weak financial condition of the issuing company. The low credit quality of these bonds makes them a risky investment option, wherein the issuer may not be able to repay the original principal. As a result,junk bonds offer higher interest than other bonds. Hence, they are also known as high-yield bonds.

The low credit quality of these bonds makes them a risky investment, as the issuer may fail to repay the original principal.

Investor perspective

Usually, asset management companies maintaining a bond fund add a few junk bonds to their portfolio to benefit from their growth potential. If, as an individual investor, you have a portfolio consisting of several investment grade bonds and one or two junk bonds, loss on one of these bonds can be recovered from the high returns of other bonds.

Upgrade and downgrade

Junk bonds are usually purchased by institutional investors as well as investors who are looking to diversify their portfolio. Under certain circumstances, a junk bond may be upgraded to investment grade due to good performance of the organization.

The reverse is also possible (a downgrade), when the financial condition of the organization issuing an investment grade bond deteriorates. Experts believe that in India, junk bonds can effectively help small and mid-sized businesses cope within adequate credit flow.


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