In the financial industry, high yield bonds are an investment vehicle that is usually rated as being below investment quality at the time they are being purchased. They are often times referred to as “junk” bonds, non-investment grade bonds, and speculative grade bonds. For the record, high yield bond investing carries a higher risk of default but they typically pay out higher yields than bonds that are of a higher quality. This is what makes high yield bonds so attractive to aggressive investors.
Bonds are actually a debt which is paid by the investors who purchase them in the hopes of a substantial gain on their investments. The holder of a debt will always be subject to two things – credit risk and interest rate risk. But the bottom line is that a high yield bond is a bond that is high-paying in nature but has a lower credit rating when they are being compared to other corporate bonds that are investment-grade.
The 3 pros and 3 cons of high yield bonds
Any time you are considering sinking your funds into any investment vehicles, one of the first things that you do after you have researched the company thoroughly is to find out what the pros and cons of the investment are. Where high yield bond investing is concerned, there are 3 pros and 3 cons as follows:
Convertibility – high yield bonds can usually be converted into the common stock of the company. Although this removes the interest, this also allows the bond to be sold at the company stock’s current market value.
Ethical concerns – anytime a bond is being used as money being loaned to a company, the fact that can do what they want with that money is oftentimes ethically and even morally objectionable to the investors involved.
Higher Coupon Rates – corporate bonds usually pay considerably higher coupon rates compared to government bonds due to the increased risk factor.
Less Security – the only thing backing a high yield bond is the company’s word. If the company fails, you have no recourse and have lost all your money. So you really want to do your homework before getting involved in high yield bond investing.
Possible losses when selling – if interest rates increase after the high yield bond was purchased or if the company becomes unstable, you could lose money if you decide to sell your bonds.
Profits from a dropping interest rate – this aspect of high yield bond investing is probably the fact that you could realize some great profits when interest rates are dropping and new bonds with lower yields are being issued. This is due to the fact that these bonds to not need to be as competitive of a financial instrument.
The primary concern for anyone interested in high yield bond investing is that you have got to do your homework so that you know exactly what the risks are, both positive and negative. Take your time to study the high yield bonds available as thoroughly as possible.
