Junk Bond

A junk bond is a loan made to a company or government that carries a high risk of not being paid back in full, and that pays a higher interest rate to compensate lenders for taking that risk. When you buy a bond, you are essentially lending money to the issuer, who promises to pay you regular interest and return your principal at a set date. Junk bonds are issued by borrowers whose financial health is shaky enough that independent credit rating agencies rate them below the "investment grade" cutoff.

Credit rating agencies like Standard & Poor's, Moody's, and Fitch assign letter grades to bonds based on how likely the issuer is to default, meaning fail to make interest payments or repay the loan. Bonds rated below a certain threshold are labeled speculative grade or "junk," a term that simply reflects elevated risk rather than the issuer being worthless or fraudulent. Because investors demand to be paid more for taking on that extra default risk, junk bonds carry higher yields than equivalent investment-grade bonds, which is why they're also called "high-yield bonds."

The nuance that trips people up is that "junk" doesn't mean "bad investment" or "about to fail." Plenty of junk-rated companies pay their debts reliably for years; the rating just signals a statistically higher chance of trouble compared to blue-chip borrowers. It's also worth knowing that the exact rating letters that mark the boundary between investment grade and junk are set by each rating agency and can be described slightly differently depending on the source, so the precise cutoff is something to check against the current published scale rather than assume.

Prices of junk bonds tend to move more with the issuer's business prospects and with overall risk appetite in markets than with interest rate changes alone, unlike high-quality government bonds. That makes them behave a bit more like stocks in how they react to economic news, which is one reason traders watch junk bond markets as a barometer of risk sentiment.