Brief Definition
Junk bonds, also known as high-yield bonds, are corporate bonds that carry a higher risk of default compared to investment-grade bonds. Because of this higher risk, they offer higher interest rates to attract investors.
Further Explanation
Junk bonds, also known as high-yield bonds, are corporate bonds that carry a higher risk of default compared to investment-grade bonds. Because of this higher risk, they offer higher interest rates to attract investors. These bonds are typically issued by companies with lower credit ratings, which means they are more likely to experience financial difficulties.
Example:
A startup company with an unstable financial history needs to raise funds for expansion. Due to its poor credit rating, it issues junk bonds with an interest rate of 10%, higher than the 5% offered by more stable, investment-grade bonds. Investors willing to take on the higher risk may purchase these bonds in hopes of earning higher returns, but they must also be prepared for the possibility that the company might default on its debt.