If you have poor credit due to being delinquent on credit card debt or other issues, chances are the bank is going to charge you a higher interest rate on a personal loan, or it might not give you a loan at all. Corporations face the same problems. If a company takes on too much debt or is otherwise considered to be a credit risk, then it also gets low credit ratings. In this case, if it wants to take on more debt it needs to issue what is known as “junk bonds,” or as corporations prefer to call them, “high-yield bonds.”
Whatever you call these types of bonds, their key feature is that they pay higher interest than bonds from a corporation that has a high credit rating. If you have a 401(k) or other retirement investment fund, chances are you have the option to make a portion of your investment in these higher risk/higher return bonds.
Do some research on junk bonds. What kind of controversies do you see with them? Do you think they are a solid investment for your retirement, perhaps no riskier than most investments? Or do they deserve the derogatory term “junk”? Share the links to the articles you find with your classmates, and discuss your opinions as to whether you think the higher interest rate justifies the increased risk.
Module 4 Week 1
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posted Oct 31, 2018 7:26 PM
Junk Bonds, or high yield bonds refer to bonds that are more speculative in nature, due to the perceived riskiness of the company or organization that issued the bonds (Amadeo, 2018). We know from our readings that the price of a bond is determined not only by the risk free interest rate, but by the risk of the bond issuer, as well as the value of the coupons and final payment given by the bond issuer (Ross, Westerfield, & Jordan, 2007).
In the past, junk bonds were less regulated and other parts of the financial markets, and as such were more vulnerable to schemes, default, etc. (Sviokla, 2009). Furthermore, we know that while there are many more bonds issued than stocks, bonds also tend to be less liquid, or sold and bought less often than stocks are (Ross, Westerfield, & Jordan, 2007). Therefore, due to lack of liquidity, regulation, and transparency, the valuation of junk bonds becomes more difficult than certain stocks. While this is changing in recent times, there is still a way to go (Amadeo, 2018). Like any investment, I believe that good due diligence, risk assessment, diversification, and research is essential before deciding; and junk bonds may be an investment I would consider using for retirement, but only in a portfolio of other investments after plenty of research into the fundamentals of the bonds themselves. In short, some bonds might still be junk, just like some stocks might be, and others might be good investments, it is up to us to find out.
Amadeo, K. (2018, April 14). Junk Bonds, Pros, Cons, and Ratings. Retrieved from The Ballance: https://www.thebalance.com/what-are-junk-bonds-pro…
Ross, S., Westerfield, R., & Jordan, B. (2007). Essentials of Corporate Finance. McGraw Hill.
Sviokla, J. (2009, April 14). A Better Way to Rate Bonds. Retrieved from Harvard Buisness Review: https://hbr.org/2009/04/a-better-way-to-rate-bonds
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posted Nov 19, 2018 12:24 PM
High-yield bonds “suffer from an identity crisis” sharing more characteristics with stocks than they sometimes do with bonds (Glassman, 2018). For this reason, they should not necessarily be considered as bad, but merely a different type of investment than other bonds issued by companies with a higher credit rating. Since they are generally considered riskier, they will have a higher yield than other bonds, and can be incorporated smartly into a diversified portfolio.
Junk bonds are not always issued by failing companies with terrible credit as they are sometimes from “companies on the rebound from hard times” (Glassman, 2018) and could prove to be a great investment. Aside from this, junk bonds are often issued by companies that are considered to be fallen angels or “companies that are historically reputable but are experiencing financial problems” (Investopedia, 2018). This, in theory, will reduce the risk of the company defaulting on the debt and your investment receiving no return from either interest or principle.
Gould states that “High yield bonds have a place in well diversified portfolios, but probably should comprise much less than half of the portfolio’s total bond allocation” (2018). Starting with this in mind and with plenty of research into the individual investment, a junk bond or high yield bond can be value added to an investment portfolio.
Thanks for reading,
Glassman, B. (2018, Mar 13). The most confused identity in your portfolio: High yield bonds. Forbes. Retrieved from https://www.forbes.com/sites/advisor/2018/03/13/the-most-confused-identity-in-your-portfolio-high-yield-bonds/#e42dacb2b8b6
Gould, D. P. (2018, July). Advisor insights Are high yield bonds a good investment? Investopedia. Retrieved from https://www.investopedia.com/ask/answers/111414/how-can-i-find-good-investments-among-lower-rated-bonds.asp
Investopedia. (2018, July). Are high yield bonds a good investment? Investopedia. Retrieved from https://www.investopedia.com/ask/answers/111414/how-can-i-find-good-investments-among-lower-rated-bonds.asp
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