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Investment Dictionary


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Junk Bonds

 

Junk bonds are bonds that have a speculative-grade credit rating, which is BB or lower. 

 

Junk bonds are riskier but they have higher yields. The spread between junk bond yield and safe bond yield (close to the risk free rate) depends mostly on few factors:

  • The rating of the junk bond. The lower the rating of the junk bond is, the bigger the spread will be.
  • Financial market situation. When volatility in the markets increases it makes to contract tolerance for risky investments and yields of junk bonds may rise drastically (value of junk bonds decreases).
  • Denomination currency of the junk bond. If safe bonds used for benchmark are issued in another currency than junk bonds, then it will also have an effect on risk premium reflected by yield. 

 

Investment in junk bonds is very risky, and sometimes such risk can be equal to stock investment risk. Especially risky are bonds of low credit rating (or no rating at all) that are denominated in some weak currency of emerging country. Because during financial market crash not only the bond will lose the value but the weak currency also may lose more than 30% of value, so the total loss may amount similar loss that can be expected from stocks. 

 

Investment in junk bonds is really risky, especially if such investments are chosen for a short-term investment. But it doesn’t mean that they all are bad investments. Junk bonds usually offer a reasonable risk-return ratio; however, such bonds have to be included in the portfolio wisely with a proper diversification

 

 






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