high-yield bonds

(noun)

In finance, a high-yield bond (non-investment-grade bond, speculative-grade bond, or junk bond) is a bond that is rated below investment grade. These bonds have a higher risk of default or other adverse credit events, but typically pay higher yields than better quality bonds in order to make them attractive to investors.

Related Terms

Examples of high-yield bonds in the following topics:

  • Characteristics of Bonds

    • The yield is the rate of return received from investing in the bond.
    • High-yield bonds are bonds that are rated below investment grade by the credit rating agencies.
    • Therefore, because of the inherent riskiness of these bonds, they are also called high-yield or "junk" bonds.
    • This is mainly the case for high-yield bonds.
    • To be free from these covenants, the issuer can repay the bonds early, but only at a high cost.

  • Redeeming Before Maturity

    • For bond issuers, they can repurchase a bond at or before maturity.
    • These bonds are referred to as callable bonds.
    • Most callable bonds allow the issuer to repay the bond at par.
    • This is mainly the case for high-yield bonds.
    • To be free from these covenants, the issuer can repay the bonds early, but only at a high cost.

  • Ratings

    • Bond ratings below BBB/Baa are not considered to be investment-grade; these bonds are called junk bonds.
    • Junk bonds are also called high-yield bonds.
    • As these bonds are more risky than investment grade bonds, investors expect them to earn a higher yield.
    • The risks associated with investment-grade bonds (or investment-grade corporate debt) are considered significantly higher than those associated with first-class government bonds.
    • Use the ratings system to assess the risk associated with different bonds

  • Call Provisions

    • A callable bond (also called redeemable bond) is a type of bond that allows the issuer of the bond to retain the privilege of redeeming the bond at some point before the bond reaches its date of maturity.
    • Most callable bonds allow the issuer to repay the bond at par.
    • This is mainly the case for high-yield bonds.
    • To be free from these covenants, the issuer can repay the bonds early, but only at a high cost.
    • Similarly, yield on a callable bond is higher than the yield on a straight bond.

  • Types of Bonds

    • The most common secured bonds.
    • This bears the owner's name on the bond certificate and in the register of bond owners kept by the bond issuer or its agent, the registrar.
    • A term bond matures on the same date as all other bonds in a given bond issue.
    • Serial bonds in a given bond issue have maturities spread over several dates.
    • These are high-interest rate, high-risk bonds.

  • Other Features

    • Other important features of bonds include the yield, market price and putability of a bond.
    • The yield is the rate of return received from investing in the bond.
    • The market price of the bond will vary over its life: it may trade at a premium (above par, usually because market interest rates have fallen since issue), or at a discount (below par, if market rates have risen or there is a high probability of default on the bond).
    • Yield on a puttable bond is lower than the yield on a straight bond.
    • Describe the effect a bond's market price has on its yield

  • Chapter Questions

    • If one bond market has a high risk while the other is low risk, then how does risk impact the bond markets?
    • If one market has high information costs while the other does not, then how would information cost affect the bond markets?
    • Explain both the term structure of interest rates and the yield curve.
    • Which three theories explain the characteristics of the yield curve?
    • If you saw a yield curve with a negative slope, which economic phenomenon would you predict to occur in a year?

  • Answers to Chapter 9 Questions

    • Thus, investors increase their demand for the low-risk bonds and decrease their demand for the high-risk ones.
    • Furthermore, the interest rates are lower for the low-risk bonds and higher for the high-risk bonds.
    • Thus, investors increase their demand for the low information cost bonds and decrease their demand for the high information cost ones.
    • Consequently, bond prices increase for the bonds with low information costs but increase for the high information cost bonds.
    • Preferred habitat theory does the best in explaining the yield curve.

  • Yield to Maturity

    • Yield to maturity is the discount rate at which the sum of all future cash flows from the bond are equal to the price of the bond.
    • If the yield to maturity for a bond is less than the bond's coupon rate, then the (clean) market value of the bond is greater than the par value (and vice versa).
    • Yield to put: same as yield to call, but when the bond holder has the option to sell the bond back to the issuer at a fixed price on specified date.
    • Yield to worst: when a bond is callable, puttable, exchangeable, or has other features, the yield to worst is the lowest yield of yield to maturity, yield to call, yield to put, and others.
    • Classify a bond based on its market value and Yield to Maturity

  • Term Structure of Interest Rates

    • Consequently, the yield curve usually slopes upward because people prefer to hold short-term bonds rather than long-term bonds.
    • Consequently, the yield curve slopes upward because the investors add the term premium to long maturity bonds.
    • Interest rate on a long-term bond equals the average of the short-term interest rates expected to occur over the life of the long-term bond.
    • However, investors add a term premium, so the yield curve has a positive slope because the term premium is high enough to cancel the effect of changing interest rates.
    • When a yield curve is downward sloping, such as a three-month T-bill interest rate exceeds the 10-year T-bond, a recession usually occurs one year later.