High Yield Bonds
High yield bonds sound great, right? Who wouldn't want a bond that paid a high rate of interest.
Unfortunately, the term high yield is also synonymous with the term junk?as in junk bonds. Junk doesn't necessarily mean
that a bond is worthless (though it can), it simply means that the bond is very risky to invest in.
What makes it risky? The risk comes from the ability?or lack thereof?of the bond issuer to make good on the
terms of the bond. Just as banks will charge a higher interest rate to borrowers that have poor credit (thus
making them a default risk), bond issuers must pay higher rates of interest when their own credit is poor. This
high rate of interest entices investors to consider the lower quality, high yielding bonds in place of the lower-yielding, but
higher quality bonds.
A bonds' credit worthiness is determined by a bond rating system. The most commonly known and popular bond raters are Moody's,
S and P, and Fitch. Below is a chart that shows each rating figure given by each company and what it means. Naturally, the lower
you go on the chart, the more interest the company would have to pay in order to entice investors to choose their bonds over
other higher quality ones.
