Junk Bonds: High Yield, Higher Risk

If Treasuries are the market’s “risk-free” IOUs, junk bonds are their shady cousins. Officially called “high-yield bonds,” they’re debt issued by companies with weaker credit ratings — BB or lower from Moody’s or S&P. In plain English: these issuers might not make it. To lure investors, they pay fat yields. Sometimes it works out. Sometimes you’re left holding paper from a company circling the drain.

The Mechanics
A junk bond works like any other: you lend money, collect coupon payments, and hope to get your principal back at maturity. The difference is the borrower’s creditworthiness. These are often smaller firms, troubled companies, or businesses in volatile industries. A junk bond might yield 7–10% when Treasuries pay 4%. That spread is your “risk premium” — the market’s way of saying: proceed at your own risk.

Why They Attract Investors

• High Yield: Retirees, pensions, and income chasers get lured in by double the coupon of safer bonds.
• Diversification (on paper): Junk bonds don’t always move in sync with stocks or Treasuries.
• Speculation: Hedge funds and traders use them as leveraged bets on turnarounds or industry rebounds.

Where Investors Get Burned

• Defaults: Junk bonds carry default rates of ~3–5% per year. In recessions, defaults can spike into double digits.
• Liquidity Traps: In good times, you can sell easily. In crises, the market dries up — prices plunge, bids vanish.
• Chasing Yield Blindly: That 9% coupon looks sweet until the company misses a payment. High yield isn’t free money — it’s compensation for real risk.

History Lessons

• 1980s Junk Boom: Michael Milken and Drexel Burnham fueled the rise of junk as a financing tool. It worked — until defaults piled up.
• 2008 Crisis: Junk bonds collapsed as credit markets froze, wiping out investors chasing income.
• 2020 Energy Crash: Oil companies loaded with junk debt imploded when crude prices fell, leaving bondholders wrecked.

The Spectrum of Junk

• Fallen Angels: Companies downgraded from investment grade — often safer than true junk, but still risky.
• Distressed Debt: Trading at huge discounts, often betting on bankruptcy recovery.
• Emerging Market Junk: Issued by foreign corporates — layered with political and currency risk.

The Bigger Picture
Junk bonds serve a purpose. They let weaker firms raise capital and give investors a shot at higher returns. But they’re the bond market’s warning siren: when spreads blow out (junk yields rise far above Treasuries), it signals fear in credit markets. When spreads tighten, it screams optimism. Traders watch this gap like hawks.

Takeaway
Junk bonds can juice returns, but they can also torch portfolios. They’re not “income plays” — they’re speculation wrapped in a coupon. If you buy junk, understand you’re betting on survival, not just yield.

👉 Question for you: Do you see junk bonds as a smart slice of diversification — or a gamble better left to hedge funds?