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Junk bond

A junk bond is a bond with a speculative credit rating by a rating agency.

Expanded Definition

Also known as high-yield bonds, these are rated as below investment grade, usually BB or lower. The issuers of these bonds -- which are judged to be at a higher risk of default -- have to pay an attractive coupon to compensate investors for the additional risk.

For instance, in order to float $1 billion worth of six-year bonds in February of 2009, Chesapeake Energy had to price it with a 10.6% annual yield. This was eight points higher than comparable Treasury notes and five points higher than a decent-quality A-rated bond.

While that yield sure looks tempting, note that junk bonds have that high a yield precisely because there is a significantly greater chance that you won't get your money back from the company. In other words, the company could default on its obligation to you. Because of this, investment ni these types of securities is best done if you know the company intimately and a high degree of knowledge of specialized credit. Further, many bonds of this nature do not allow the investor to cash out for a minimum period of time such as one or two years. Thus your capital is tied up at least that long. It is certainly not for the faint of heart.

However, investing a small portion of your portfolio in a high-yield bond fund may be worth your time. Presumably the fund manager has the specialized knowledge and expertise to be successful and due to the larger number of holdings in the fund (as opposed to your likely limited resources), if a few default, not all is lost.

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