Junk Bonds

Junk bonds, or speculative grade bonds or high yield bonds, are bonds rated BB and below. These bonds are issued by companies with a high risk of default. Due to this high risk, the issuers of junk bonds usually offer high interest rates to compensate investors for the higher risk involved.

As junk bonds are rated below investment grade bonds (i.e., AAA bonds to BBB bonds), they fall under the speculative-grade category, i.e., the issuer's ability to meet the interest and principal obligations is considered to be ‘speculative’.  

Capital Appreciation

The credit rating of an issuer's company can improve financial performance, lower debts, increase cash flow or better market conditions. This can lead to an increase in the price of a bond, allowing investors to benefit from capital appreciation. Aggressive investors aiming for capital appreciation in addition to interest income can invest in junk bonds. 

Potential for Higher Returns

Usually, junk bonds offer higher coupon rates compared to investment-grade bonds due to the high risk investors are willing to take. The additional return can help investors improve the overall portfolio performance.

Diversification

The risk–return profile of junk bonds differs from stocks and investment-grade bonds, helping investors diversify their portfolios and earn higher yields.  

Credit Risk

Credit risk or default risk refers to the possibility of an issuer failing to make timely interest or principal payments. As junk bonds are issued by companies rated BB and below, they have a higher chance of default in repayments. Therefore, credit risk is an important factor for investors to consider when investing in lower rated bonds.

Interest Rate Risk

The price and the interest rates of the bond are inversely related. When interest rates rise in the market, the value of the bond falls and vice versa. This risk is higher in those junk bonds having longer tenures. Those seeking to avoid this risk should hold their bonds till their maturity dates.

Downgrade Risk

If a credit rating agency such as CRISIL or ICRA downgrades a junk bond further due to low financial performance or higher debt obligations, the market value of the bond can fall sharply.

Liquidity Risk

Junk bonds usually have lower liquidity due to the high credit risk involved. Due to this, investors find it difficult to sell their bonds at a desired price before maturity in the secondary market, particularly during market fluctuations.

Market Risk

Junk bonds are highly volatile compared to AAA to BBB bonds, as they are sensitive to the issuer’s performance and economic conditions. During periods of market downturn, the price of junk bonds can be negatively affected. 

Investing in bonds in India involves two routes – buying bonds directly from the issuer, i,e., primary market, or purchasing from existing investors, i.e., secondary market. Investors should have a demat and trading account to buy listed bonds.

Primary Market

In the primary market, investors buy 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. High-net-worth individuals (HNIs) can buy high yield bonds through financial advisors or through private placements.

Secondary Market

In the secondary market, investors can purchase bonds from the existing investors through stock exchanges - NSE or BSE. Alternatively, investors can also purchase junk bonds through registered Online Bond Platform Providers (OBPP).

Investors have to pay tax on interest income and capital gains (if sold before maturity in the secondary market). Let’s understand in detail:-