High-Yield Bond (Junk Bond)

High-yield bonds, also known as junk bonds, are corporate bonds with credit ratings below investment grade (BB+ or lower from S&P). They offer higher yields to compensate investors for the increased risk of default.

Credit Rating Scale:

Rating	Category	Risk Level
AAA, AA, A	Investment Grade	Low
BBB	Investment Grade	Moderate
BB, B	High Yield	High
CCC, CC, C	High Yield	Very High
D	Default	In default

High-Yield Bond Characteristics:

• Yield: 3-8% above Treasury bonds
• Default rate: Historically 2-5% annually (higher in recessions)
• Recovery rate: 40-50% of face value typically
• Duration: Similar to investment grade
• Correlation: More correlated with stocks than other bonds

Risk/Return Profile (Historical):

Asset Class	Avg Annual Return	Volatility
Treasury bonds	4-5%	Low
Investment grade	5-6%	Low-Medium
High-yield bonds	6-8%	Medium-High
Stocks	10%	High

Why Companies Issue High-Yield:

• Startups without credit history
• Leveraged buyouts (LBOs)
• Companies in financial distress
• Cyclical industries (airlines, energy)
• Growth companies with high debt

High-Yield Investment Options:

• Individual bonds - High minimums, research intensive
• Mutual funds - Diversified, professional management
• ETFs - HYG, JNK, USHY, SHYG (short-term)

When to Consider High-Yield:

• Economic expansion (lower defaults)
• Wide credit spreads (value opportunity)
• Part of diversified fixed income allocation
• 10-20% of bond portfolio typically

Risks to Understand:

1. Default risk - Company may not pay
2. Liquidity risk - Hard to sell quickly
3. Interest rate risk - Still rate sensitive
4. Economic risk - Defaults spike in recessions
5. Concentration risk - Some sectors overrepresented