Corporate Bond: High Yield Equals High Risk

When investing in a corporate bond, you may be enticed by the high yield that it promises. While a high yield is nice to have, it typically comes with strings attached. High yield corporate bonds come with their fair share of risk as well. Here are a few things to consider about high yield bonds and how risky they are. 

Bond Ratings

Corporate bonds come with a rating according to a few of the financial experts in the market. For example, Standard & Poor's and Moody's come out with bond ratings on all of the corporate bonds in the market. These ratings go from "AAA" all the way down to "D" and can tell you a lot about the company that issued the bond.

The bonds with a "AAA" rating have the best credit profiles and business history behind them. These are usually the popular companies that have been around for many years. Experts feel safe in recommending them and believe that they will be around for the long haul. Companies with a "BB" rating or lower are considered higher risk bonds. Many refer to these types of bonds as junk bonds.

High Risk High Reward

While the name "junk bond" implies that you should stay away from this type of investment, that may not always be the case. Sometimes, junk bonds can be a very good investment. Whenever a company falls in this category, it is because they have bad credit histories. This means that they will have to pay a higher rate of interest on the bonds that they issue. They can not find the same low interest rates that the "AAA" companies can get. Therefore, they have to pay higher rates if they want to attract investors and raise the money that they need for business purposes. As an investor, this means that you can get a great interest rate for your investment as compared to the lower risk bonds.

Increased Risk for Investors

Although you are getting a better return on your investment, you also have to stomach the increased risk that comes with it. These companies did not get these bad credit ratings by accident. They usually got them by making bad business decisions or taking on too much debt. This means that they are at an increased risk of default. The only thing that really scares bond investors is the thought of default. Since bond interest is fixed, it does not depend on the performance of the company like stocks do. As long as the company stays afloat, you will receive your interest.

If the company goes out of business, your initial investment is at risk. There is a chance that you will get your money back because you are a creditor of the company. However, you are not guaranteed anything. If the company does not have enough assets to satisfy all of the outstanding debts, someone is not going to get their investment back. Therefore, you should only invest in these junk bonds if you can handle the possibility of losing your entire investment.  

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