High yield bonds, frequently referred to as “junk bonds”, are debt obligations of companies which are considered to be high credit risks. They typically pay a higher yield than investment grade bonds to compensate investors for taking on additional risk.
Like all corporate bonds, junk bonds typically trade over the counter through dealers and their liquidity depends on a variety of factors.
Oftentimes investment grade bonds will be downgraded due to business difficulties of the issuer, and begin trading at a significant discount to their par value as a result. Such issues are frequently referred to as “fallen angels”. These junk bonds should be viewed by prospective investors with caution as they could be an indication of an imminent default of the issuer.
As an asset class, high yield bonds tend to be slightly less risky than stocks, and significantly more risky than most investment grade corporate bonds.
Like all fixed income instruments, junk bonds are susceptible to interest rate risk, which increases as the duration of the bond increases.
Junk bonds can be a valuable addition to an investment portfolio, however caution should be taken before allocating them to accounts whose owner has a short time horizon or low risk tolerance.