What is junk bond?
A junk bond is a type of bond with a higher risk than standard bonds. It typically carries a lower credit rating and thus has to offer investors a higher yield to compensate them for the greater risk of default that co-borrowers are co-signing on the loan.
Why is it called a junk bond?
A junk bond, also known as a high-yield bond, is viewed as a higher-risk investment instrument since it offers investors greater returns than typically seen with regular government or corporate bonds. As such, its name implies the potentially hazardous nature of these investments is similar to "junk," given that debt issuers may fail or not be able to meet their financial obligations on time. Yet for investors willing to accept such risks, junk bonds can provide lucrative rewards if managed properly.
Pros and Cons of Investing in Junk Bond
Investing in junk bonds can have its advantages and disadvantages. On the positive side, they typically offer a higher rate of return than other investments with similar credit risk ratings, so they can potentially be a lucrative option for investors with a high-risk tolerance. However, these types of bonds also carry a greater risk of default, meaning that there’s no guarantee that an investor will always get the full return on their investment.
There is also the matter of liquidity; if an investor needs to cash out quickly, it could be more difficult to find buyers for a junk bond than one with a better rating. Ultimately, investors should weigh carefully the potential rewards against the risks before making any decisions about investing in junk bonds.