High yield bonds, also known as junk bonds, are fixed-income securities issued by a company or country with a low credit rating and they tend to be rated below the investment grade. These types of bonds are characterised by a high risk of default on both interest and the principal, but they offer higher return. The 'junk bond' classification is largely determined by two factors:
The speculative grade rating of the bond issuer.
The actual structure of the bonds.
When assigning an issuer a high yield rating, rating agencies take into account whether they have special financing needs, high levels of indebtedness, whether they belong to a certain sector that implies greater risk, and whether the issuer is known in the market.
It is not just speculative grade companies that issue junk or high yield bonds; they can also be issued by investment grade companies. The companies that issue these types of bonds are mainly looking to obtain funds with a longer maturity while simultaneously diversifying their sources of financing
The junk bond market often has specialised investors who are willing to assume a higher risk for a higher return. Most 'traditional investors'“” are not allowed to invest in these types of bonds.
Debts rated as very low offer much higher returns, making them attractive instruments for certain financial strategies. The value of junk bonds is affected to a greater extent than investment grade bonds because of the potential for default.