Junk bond

A junk bond is a bond that has been assigned an investment grade of BB or lower by a credit rating agency. The key characteristics of a junk bond are as follows:

  • It is unsecured or only partially secured by collateral
  • The issuer is either unknown to the debt markets or is well-known but highly leveraged

The issuer of a junk bond is forced to offer a high interest rate in order to attract investors. Because of the high interest rate and potentially weak supporting cash flows of the issuer, these bonds tend to have a high risk of default. Because of their speculative nature, junk bonds are typically excluded from the allowed range of investments for many large corporations and investment funds. Conversely, some investors will buy junk bonds, hoping that the associated investment grade will eventually improve, which will then trigger an increase in the price of the bond.

These bonds are commonly issued in order to finance a leveraged buyout, where a large proportion of debt is being used to acquire a business. In a leveraged buyout, the bonds are paid off either by liquidating a selection of company assets or by internally generated cash flows.

Related Courses

Corporate Finance 
Treasurer's Guidebook