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What is a High-Yield Bond?
A high-yield bond is a debt security issued by entities with lower credit ratings, offering higher interest rates to compensate investors for increased risk. These bonds are commonly referred to as junk bonds.
Definition
A high-yield bond is a bond with a lower credit rating that pays higher interest due to elevated default risk.
Key Takeaways
- Offers higher yields than investment-grade bonds.
- Carries greater credit and default risk.
- Commonly used by companies with weaker balance sheets or aggressive growth strategies.
Understanding High-Yield Bonds
High-yield bonds are rated below investment grade by credit rating agencies such as Moody’s, S&P, and Fitch. Because issuers are considered riskier, investors demand higher yields as compensation.
These bonds are widely used in leveraged buyouts, corporate restructuring, and growth financing. While they can enhance portfolio returns, they are more sensitive to economic downturns and interest rate changes.
Investors often evaluate high-yield bonds based on credit spreads, issuer fundamentals, and macroeconomic conditions.
Real-World Example
A fast-growing company with a BB credit rating issues bonds paying 8% interest, compared to 4% for investment-grade bonds. Investors accept the higher yield in exchange for greater risk.
Importance in Business or Economics
High-yield bonds:
- Provide access to capital for riskier firms
- Influence credit market conditions
- Reflect investor risk appetite
- Play a role in mergers, acquisitions, and restructurings
Types or Variations
- Fallen Angels — Former investment-grade bonds downgraded
- Rising Stars — High-yield bonds upgraded to investment grade
- Distressed Debt — Bonds near default
Related Terms
- Investment-Grade Bond
- Credit Rating
- Bond Yield
Sources and Further Reading
Quick Reference
- Below investment-grade rating
- Higher yield, higher risk
- Sensitive to economic cycles
Frequently Asked Questions (FAQs)
Why do investors buy high-yield bonds?
For higher income and potential returns.
Are high-yield bonds always risky?
Yes, but risk varies by issuer and market conditions.
How do interest rates affect high-yield bonds?
Rising rates can pressure prices, especially for weaker issuers.
