JUNK BOND
A security issued by a corporation that is consid-
ered to offer a high risk to bondholders.
Junk bond is the popular name for high-risk
bonds offered by corporations. A bond is a cer-
tificate or some other evidence of a debt. In the
world of corporate finance, a corporation may
sell a bond in exchange for cash. The bond con-
tains a promise to repay its purchaser at a certain
rate of return, called a yield. A bond is not an
EQUITY investment in the corporation; it is debt
of the corporation.
A corporate bond is essentially a loan to a
corporation. The loan may be secured by a lien
or mortgage on the corporation’s property as
security for repayment.
To determine the level of the default risk for
potential bondholders, financial experts analyze
corporations and rate them on a number of fac-
tors, including the nature of their business, their
financial holdings, their employees, and the
length of their existence. The higher the risk for
bondholders, the lower the risk rating given the
corporation.
Because their ventures are considered risky,
low-rated corporations must offer bond yields
that are higher than those of high-rated corpo-
rations. High-rated corporations have less need
for income from bonds, so they do not need to
offer high yields. Bonds from these companies
are called investment-grade bonds. Low-rated
corporations have the need for bond income, so
they offer high-yield bonds. These high-yield
bonds are junk bonds.
When a corporation fails, bondholders may
lose all or part of their investment if the corpo-
ration has declared BANKRUPTCY or has no
assets. This possibility is more real for junk
bonds because they are, by definition, issued by
unproven or unhealthy corporations.
For some persons, the high yield of a junk
bond can be worth the increased risk of default.
Junk bonds can increase in value if the corpora-
tion’s rating is upgraded by private bond-rating
firms. Junk bonds are also favored by some per-
sons precisely because they contribute capital to
young or struggling corporations. Whether to
buy a junk bond depends on the investor: con-
servative investors do not favor them, but spec-
ulators and others seeking a quick profit find
