I Thought These Would Be Junk Bonds But They're Actually High-Yield Investments

I was surprised to discover that some of the bonds I had written off as junk bonds were actually high-yield investments. This was particularly true for bonds issued by companies with a history of default, which often carry higher interest rates to compensate for the increased risk.

These high-yield bonds, also known as non-investment-grade bonds, have a lower credit rating than investment-grade bonds. According to the article, companies with a credit rating below BBB- are considered non-investment-grade.

High-yield bonds are bonds that pay a high relative rate of interest. This is because they often carry a higher degree of risk associated with the bond issuer.

High-yield bonds are commonly referred to as "junk bonds" because they have a lower credit rating, making them riskier investments. The trade-off is that safer bond investments typically have a lower yield.

Bonds are graded on their riskiness, also known as their creditworthiness. This means that high-yield bonds have a lower credit rating compared to investment-grade bonds.

A default can occur when the issuer is unable to make timely payments, and in some cases, the principal amount cannot be repaid to the lender. This highlights the higher risk associated with high-yield bonds.

Investment-grade bonds come from corporations with a high probability of paying regular coupons and returning the principal to investors. They're considered "safe" investments.

These bonds are rated by agencies like Standard & Poor's, which uses a scale from AAA (excellent) to BBB (adequate).

High-yield bonds, on the other hand, pay a higher relative rate of interest because they have a higher degree of risk associated with them. This is why they're often referred to as "junk bonds."

The trade-off is that "safer" bond investments typically have a lower yield, so bonds with lower credit ratings must offer higher coupon rates.

Investment Grade bonds come from corporations with a high probability of paying regular coupons and returning the principal to investors. This is a key characteristic that sets them apart from other types of bonds.

Standard & Poor's ratings provide a clear indication of a bond's investment grade. For instance, their ratings include AAA, which is considered excellent, and AA, which is very good.

Investors seeking low-risk investments often turn to investment-grade bonds. These bonds are generally considered safer than other types of bonds, making them a popular choice for those seeking stable returns.

Here are some examples of Standard & Poor's investment-grade ratings:

Penny stocks are stocks with very low share prices — typically less than $5 per share, and often, under $1 per share.

These stocks are very risky and speculative, which is why they may be considered the "junk bonds" of the stock market.

Their low prices don't necessarily mean they're a safe bet, as huge gains are possible but not guaranteed.

Credit ratings are a crucial aspect of bond investing, and understanding them can help you navigate the world of junk bonds. A credit rating is an assessment of a company's creditworthiness, and it's assigned by credit-rating agencies like Standard & Poor's and Moody's.

These agencies use a grading system, with AAA being the best rating and D being in default. Junk bonds typically have a lower rating, such as BB or B, indicating a higher risk of default. In fact, any bond with a rating lower than BB is considered a junk bond, which should be a red flag for risk-averse investors.

If a bond misses a principal and interest payment, it's considered to be in default. This is a major concern for junk bond investors, as the risk of default increases during economic downturns. In fact, high-yield bonds offer a higher rate of return because they have a higher risk of default, but this also means investors could lose all their money, including the principal amount invested.

Here's a breakdown of the credit rating scale for junk bonds:

In summary, credit ratings are essential for understanding the risks associated with junk bonds. By knowing the credit rating scale and the risks involved, you can make informed investment decisions and avoid potential pitfalls.

High-yield bonds offer a higher rate of return because they have a higher risk of default than investment-grade bonds. This means that investors may be more likely to lose their principal amount invested if the company defaults on payments.

During a default, it is possible for an investor to lose all money. Unstable companies are particularly vulnerable to collapse, especially during a recession.

The rating agencies seek to identify these companies. They use a grading system to assess the creditworthiness of a bond, with lower ratings indicating a higher risk of default.

Here's a breakdown of the junk bond credit ratings as expressed by the dominant rating agencies:

In the event of a company collapse, bondholders get priority over stockholders when it comes to being paid out. This means that bondholders are first in line to receive their share of the assets.

Bondholders take precedence over stockholders because they have a secured claim on the company's assets. This is why a high-yield bond can be considered safer than a stock for the same company.

If a company is unable to pay its debts, bondholders will be paid out before stockholders, ensuring they receive some value for their investment. This is a key consideration for investors looking to minimize their risk.

I thought these would be junk bonds, but it turns out they're actually high-yield bonds. Let's explore the pros and cons of these investments.

Higher investment yields are a major advantage of high-yield bonds, as they typically pay a higher interest rate than investment-grade bonds.

Lower risk than stocks is another benefit, as bondholders are paid back before stockholders in the event of a company bankruptcy.

Recurring payments are also a plus, as the typical junk bond includes an ongoing "coupon" payment until the bond matures.

Here are some of the key pros and cons of high-yield bonds:

The risk of default increases during economic downturns, making these bottom-level debts even riskier.

Buying and selling high-yield bonds can be a bit tricky, but don't worry, I've got you covered.

Individual investors can buy junk bonds directly through their brokerage account, but this option isn't ideal for most people because it doesn't offer effective diversification.

You can buy a junk bond mutual fund or exchange-traded fund (ETF) as a more accessible route into the bond markets. These funds give you exposure to a diverse basket of junk bonds with a single purchase.

ETFs are bought and sold like stocks, and they're a great option because they offer diversification and can be traded quickly.

Mutual funds are another option, but they're bought and sold in overnight batches.

If you decide to buy individual bonds, be aware that they may be difficult to resell because bond trading isn't as fluid as stock trading.

Here are some options for buying high-yield bonds:

Before investing in a junk bond fund, make sure to check the fund's fees, historical performance, and ratings.

Tesla's bond issued in 2014 had a maturity date of March 1, 2021 and a fixed semi-annual coupon rate of 1.25%.

This bond was initially rated B- by S&P, but was later upgraded to BB- in 2020, indicating a reduced risk of nonpayment but still significant uncertainty.

The bond's price skyrocketed to $577 in October 2020, a huge premium over its face value of $100, due to its convertibility to equity.

Tesla's stock price soared 600% over the last 12 months ending October 26, 2020, making the bond an attractive investment opportunity.

The BB- rating from S&P means the bond is considered less vulnerable to nonpayment, but still faces major uncertainties or exposure to adverse business or economic conditions.

In this case, investors were able to capitalize on the bond's premium price and Tesla's skyrocketing stock price, making it a valuable investment.

Credit rating agencies play a crucial role in determining the creditworthiness of a bond issuer. There are two main credit-rating agencies: S&P Global Ratings and Moody's.

Both agencies have their own grading systems, with S&P's system starting at AAA and Moody's at Aaa. Bonds with a rating below BBB are considered high-yield or junk bonds.

High-yield bonds are generally classified as below a BBB rating with S&P and a Baa rating with Moody's. These bonds are considered highly speculative and come with a higher risk of default.

Here's a comparison of the two agencies' grading systems:

A bond's credit rating can change over time, and an improvement in the rating can lead to an increase in the bond's price. This is what happened with Tesla's bond, which was upgraded from B- to BB- in 2020, resulting in a significant increase in its price.

While a higher credit rating is generally a good thing, it's essential to remember that even high-yield bonds can appreciate in value if the issuer's creditworthiness improves.