High-yield bonds, also known as junk bonds, are debt securities issued by organizations rated below investment grade. They are considered risky and have a higher default rate, so investors require higher coupon interest rates. Market changes and creditworthiness can affect the value of the bond, and they are generally more volatile than less-risky bonds. Credit rating agencies rate issuers and specific bond issues, and investment banks underwrite and sell them to investors. There may be a conflict of interest between credit rating agencies and investment banks.
A high-yield bond is a debt security issued by a corporation, government entity, or other financial organization rated below investment grade by a credit rating agency. Therefore, a high-yield bond is considered to be relatively risky in terms of the likelihood that investors will receive timely interest and principal payments. As a class, high yield bonds also have higher default rates than investment grade bonds. Therefore, investors generally require high-yield bonds to pay higher coupon interest rates. High yield bonds are also known as speculative grade or junk bonds.
As with all bonds, investors in high-yield bonds assume the risk that market interest rates, economic conditions, and the issuer’s creditworthiness may change during the life of the bond. Such changes may adversely affect the value of the bond and the issuer’s ability to pay interest and principal under the terms of the bond indenture. Because they have a comparatively high coupon interest rate, high-yield bonds typically include a call provision. This allows the issuer to repurchase the bonds from investors at pre-set prices after a specified date.
High-yield bonds are generally more volatile than higher-risk, less-risky bonds. With a higher coupon interest rate, the price of a high yield bond will change more than that of a lower coupon bond for a given interest rate adjustment, all other things being equal . In addition, the risk of an adverse credit event, such as a default, by the issuer of a high yield bond is greater than that of investment grade debt securities.
Credit rating agencies routinely rate issuers of bonds and specific bond issues to streamline and make the process of raising capital by issuing debt securities, such as high-yield bonds, more efficient. Standard & Poor’s, Moody’s, and Fitch ratings are the three major rating agencies in the United States, and each uses its own rating system to indicate a bond’s credit quality. Corporations and other organizations that issue high-yield bonds do so through investment banks, which “underwrite” the securities. This means that they buy them from the issuer and sell them to investors, usually over the course of one or more days. Investment banks pay credit rating agencies to rate the bonds before they are issued. Therefore, there may be some conflict of interest in the relationship between them; This is a problem that high-yield bond investors need to be aware of.
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