What Is a Junk Bond?

Junk Bond Definition

A bond is a certificate of debt that an investor buys from a company in exchange for interest payments as well as an eventual repayment of the principal.

A junk bond is a bond that carries a high risk of default, or a high risk that the issuing company will not be financially able to pay back its investors.

These could be issued by small start-ups as well as larger companies that are struggling financially.

To compensate for the increased risk to investors, these bonds also usually offer higher interest payments.

Because of this they are sometimes referred to as “high-yield bonds.”

Buying Junk Bonds

While buying junk bonds is significantly more risky for investors than buying historically safe bonds (so called “investment grade bonds” ), if the issuing company’s financial state improves, investors stand to see good returns.

The interest rate on a bond, also called its coupon rate, doesn’t change once issued.

If a company issues a junk bond with, say, a 15% coupon rate while the prevailing rate is 5%, and the company survives, then an investor holds a significantly valuable bond.

Junk Bond Interest Rates

Investors who buy junk bonds don’t always do so just for the interest payments.

If the issuing company is financially sound, high coupon rate bonds can be sold for well above the price originally paid.

Junk Bond FAQs

A junk bond is a bond that carries a high risk of default, or a high risk that the issuing company will not be financially able to pay back its investors.
A bond is a certificate of debt that an investor buys from a company in exchange for interest payments as well as an eventual repayment of the principal.
These could be issued by small start-ups as well as larger companies that are struggling financially.
While buying junk bonds is significantly more risky for investors than buying historically safe bonds (so called “investment grade bonds”), if the issuing company’s financial state improves, investors stand to see good returns.
Since most brokers don’t deal in such low-grade bonds, they became known as junk bonds. But since they typically offer high interest rates, some refer to them as high-yield bonds.
True Tamplin, BSc, CEPF®

About the Author
True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True contributes to his own finance dictionary, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website, view his author profile on Amazon, his interview on CBS, or check out his speaker profile on the CFA Institute website.