Junk bond as a name can be confusing because in dictionary it means anything that is regarded as worthless but in finance it can be defined as a high yield bond that is rated below investment grade at the time of purchase and considered as speculative grade. These bonds have an elevated risk of default but these bonds usually pay higher yields than better quality or investment grade bonds in order to make them attractive to investors. Here are some of the advantages of junk or high yielding bonds –
1. Many good companies face financial crisis at various stages of their existence which causes a company’s debt obligations to be downgraded to a level below investment grade and hence it is not that only below par company’s issue junk bonds, good companies also issue junk bonds.
2. From the investor’s viewpoint, junk bonds provide both income as well as potential for capital gains. Also they can be a good source for diversification for the investors.
3. Junk bonds do not correlate exactly with either investment-grade bonds or stocks. Since their yields are higher than investment-grade bonds, they’re less susceptible to interest rate change which is not the case with investment grade bonds.
4. These bonds are tradable in secondary market and hence provide liquidity to the investors.
However before investing in junk bonds of any company investor should look into detail about interest rate risk, credit risk, inflationary risk, currency risk, liquidity risk, default risk, maturity risk and market risk which are associated with such bonds.