Junk Bond
Quick Definition
A bond rated below investment grade (BB+/Ba1 or lower), offering higher yields to compensate for elevated default risk.
Key Takeaways
- Rated below BBB-/Baa3 by major credit rating agencies
- Higher yields compensate for greater default risk
- The high-yield market exceeds $1.5 trillion in outstanding debt
- Spreads over Treasuries widen during economic stress and tighten during expansions
What Is Junk Bond?
Junk bonds, more formally called high-yield bonds or speculative-grade bonds, carry ratings below BBB- (S&P/Fitch) or Baa3 (Moody's). These bonds offer significantly higher yields than investment-grade securities to compensate investors for the increased risk of issuer default. The high-yield market was revolutionized in the 1980s by Michael Milken at Drexel Burnham Lambert, who demonstrated that diversified portfolios of junk bonds could deliver attractive risk-adjusted returns. Today, the high-yield market exceeds $1.5 trillion and includes bonds from leveraged buyouts, companies undergoing restructuring, and "fallen angels" — formerly investment-grade issuers that were downgraded.
Junk Bond Example
- 1A CCC-rated company might issue bonds at 10–12% yield when investment-grade bonds yield 4–5%
- 2During the 2020 COVID crash, high-yield bond spreads widened to over 1,000 basis points before the Fed intervened
Related Terms
Investment Grade
A bond rating of BBB-/Baa3 or higher, indicating relatively low credit risk and suitability for conservative investors.
Bond Rating
A credit quality grade assigned by rating agencies (S&P, Moody's, Fitch) that assesses the issuer's ability to repay principal and interest.
Default Risk
The probability that a bond issuer will fail to make scheduled interest or principal payments, potentially resulting in partial or total loss for bondholders.
Credit Spread
The yield difference between a corporate bond and a risk-free government bond of similar maturity, reflecting the market's assessment of credit risk.
High-Yield Bond (Junk Bond)
Bonds rated below investment grade (BB+ or lower) that offer higher interest rates to compensate for increased default risk.
Bond
A fixed-income debt security where investors loan money to an issuer in exchange for regular interest payments and return of principal at maturity.
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