High Yield Bonds

High Yield Bonds, commonly known as junk bonds, offer higher returns than investment grade bonds. These bonds are issued by companies rated below investment grade credit ratings and therefore have a higher risk of default. Because of this higher credit risk, issuers of high yield bonds offer higher coupon rates to compensate investors for the higher risk involved.

As high yield bonds are rated BB and below, they fall under the speculative-grade category, i.e., the ability to meet the payment obligations is considered to be ‘speculative’.

Potential for Higher Returns

High yield bonds offer higher returns compared to investment-grade bonds. The additional return can help investors improve the portfolio’s overall performance, especially in a low-interest-rate environment. The bond issuers provide a higher rate of return to compensate investors for the increased risk they are willing to take.

Capital Appreciation

If the economic growth improves or the issuer’s business performs better, its credit rating can improve. This can lead to an increase in bond prices, enabling investors to benefit from capital appreciation in addition to interest income.

Diversification

The risk–return profile of high yield bonds differs from investment-grade bonds and equities, helping investors diversify their portfolios.

Credit or Default Risk

Higher credit risk or default risk refers to the possibility that an issuer may fail to make timely interest or principal payments. As high-yield bonds are issued by lower rated companies with a higher chance of default, credit risk is an important factor for investors to consider when investing in high-yield bonds.

Liquidity Risk

Liquidity risk refers to the risk that investors are unable to sell their bonds at a fair price in the secondary market. Choosing listed high yield bonds having sizable trading volume can help reduce this risk for the investor.

Interest Rate Risk

Bond prices and interest rates are inversely related to each other. When interest rates rise, the market price of the bond falls and vice versa. This risk is higher in those high yield bonds having longer tenures. Those seeking to avoid this risk should aim to stay invested in their bonds till their maturity dates.

Market Risk

High yield bonds are more volatile compared to investment-grade bonds, which makes them more susceptible to market fluctuations. During periods of economic downturn, the coupon rate and face value of high yield bonds can be negatively affected. This can lead to a decline in the bond’s value.

Investors can invest in high yield bonds through both the primary and secondary markets. In the primary market, investors purchase bonds directly from the issuer at the time of bond issuance. A company can issue bonds either through a public issue, i.e., inviting people to subscribe to its bonds, or through private placements.

In the secondary market, investors can buy bonds directly from the existing bondholders through stock brokers and an Online Bond Platform Provider (OBPP).

The taxation on high yield bonds involves two components, i.e., capital gains and interest income. The taxation on capital gains depends on how long you have held the bonds. Short Term Capital Gains (STCG), i.e., held for a duration of up to 12 months, are taxed according to the tax slab rate of an investor. Long Term Capital Gains (LTCG), i.e., held for a duration of more than 12 months, are taxed at 12.5% for listed bonds (without indexation benefit) and 20% for unlisted bonds. The interest income earned from a high yield bond is taxed as per the bondholder’s income tax slab.