Those who begin to study issues related to investing free funds often feel confused by the abundance of terms. From the first try it is not always easy to figure out how, for example, different types of bonds differ from stocks. One of the most questionable types of securities is the so-called "junk" bonds.
What is a bond
Any types of securities are issued with one purpose - to attract a certain amount of funds. In this sense, bonds are no exception. In its most general form, a bond is a security that can bring its holder a predetermined income.
The bond issuer can be a government or a private company. The release of such obligations is carried out for a strictly agreed period. Whoever purchases the bond actually becomes the lender of the issuing company.
Upon the expiration of the validity period of the security, the issuer is obliged to pay its holder the value indicated in the par value, as well as a percentage called the coupon yield.
A positive property of a bond, when compared to a stock, is that the investor only bears risk as a last resort, for example, if the company is officially declared bankrupt. In this sense, government securities are more reliable than corporate ones, since governments do not go bankrupt too often. A bond, unlike a stock, guarantees the return of the invested funds along with interest when the security is canceled.
The bondholder knows in advance what the payments will be when the security expires. In this case, payments can be made at different intervals during the term of the obligation: once a quarter, six months or once a year. If the market moves up, the bond's value may increase accordingly. But when the market falls, the income remains fixed.
Junk Bond: Increased Risk with High Yield
A “junk” bond is a bond with a higher risk of transactions. This negative moment is usually offset by a higher interest rate on the security, which makes the purchase very attractive for the investor. Specialists sometimes use other terms for these financial instruments, calling them "high yield", "junk" or "speculative" bonds.
Typically, junk bonds have a very low investment grade.
An investor who decides to purchase a security of this category, in fact, focuses only on his intuition and trust in the issuing company. Such companies most often do not yet have a long history and cannot boast of a solid reputation in the business world. Issuing junk and high yield bonds for these companies is often one of the ways to gain market confidence.