What are junk bonds and is it worth investing in?

Junk bonds (high-yield bond, non-investment-grade bond, speculative-grade bond, junk bond) are speculative securities with an extremely low credit rating. They are characterized by a negative financial reputation and high risks. However, this is a highly profitable instrument, trading in which allows you to get large profits. Bonds are issued with high interest rates, attracting entrepreneurs who want to buy out their companies that are about to go bankrupt.
Investors choose this instrument because of its high yield compared to traditional securities. The return on safe bonds is guaranteed to be 10% per annum. Whereas, the yield on junk securities can reach 200%, however, the likelihood that the issuer will pay off its debts is extremely small.
Probability of default junk bond [/ caption] Despite this, there is a category of investors who invest in this highly risky instrument. Junk bonds are issued by low-profile companies in order to quickly raise working capital for doing business or paying off debts. In addition, they are issued during takeovers to replace money for investors.

How the history of the junk bond market began

The history of the junk bond market began in the 70s of the XX century. Michael Milken has done analytical research on unrated securities. He was able to prove that building a diversified portfolio of low-grade bonds is more profitable in the long term than highly rated instruments. However, in this case, the probability of default increases significantly. Michael Milken has identified the cyclical nature of the market, which consists in periodic downturns in safe securities, it is at this time that the rise of junk bonds begins.
There are several types of such papers:

• fallen angels – firms that previously had a high rating, but now faced certain difficulties;
• rising stars – startups with small assets and insufficient financial strength, which have a low rating;
• High-debt companies are practically bankrupts or actually acquired companies with huge debts;
• Capital-intensive companies are firms that have insufficient capital or enterprises that are unable to obtain loans, as well as those wishing to attract investors from among individuals and legal entities.

How to invest in junk bonds the right way

Before investing in this instrument, it is necessary to calculate how expedient it is and analyze the existing risks. Initially, the market is analyzed to study the history of the issuing companies. A market research is being conducted to get an idea of ​​the current economic activity and other factors affecting the solvency of firms. You will need to take care of investment diversification and buy securities from several issuers. Based on the analysis carried out, a long-term forecast of interest rates and the dynamics of their change is carried out. The instrument’s profitability and its behavior in the market are characterized by a number of features:

• active use of debt obligations in the market with their profitability exceeding the profit on rating assets;
• an increase or decrease in the interest rate does not affect the price of the instrument, which cannot be said for ordinary debt obligations. This is due to the short maturity period and the high return on the asset;
• profitability on junk bonds directly depends on the situation in the economy.

The behavior of these assets is comparable to the dynamics of shares, since their profitability depends on the stability of the state of the issuer and its strengths. If the economy enters a period of recession, the price of junk paper drops significantly, as the size of the issuer’s earnings decreases. If the profitability of the company increases, then the value of bonds increases significantly. The stability of the economy in the state reduces the risks of working with debt obligations. High yield bonds (HVO), history of formation, current state, is it worth investing in junk bonds and how not to lose money, junk bond market in Russia: https://youtu.be/j8FsQKE2l84

How to choose an issuer

Investors recommend investing in junk bonds no more than a quarter of the savings. To reduce risks, the share of one issuer in the portfolio should not exceed 5%. Experienced investors rarely invest in this type of assets more than 10% of their funds in circulation. When choosing bonds to buy, it is necessary to study the activities of the issuer, in particular, find out if he has other securities and debt obligations. They pay attention to the company’s public debts and the total amount of debt burden, which determines the possibility of on-lending in a situation with an increased risk of default. The prospects of the business with which the company is connected are also taken into account. The prospect of a business idea will most likely help the company settle with its creditors.
To reduce risks, you need to invest in bonds issued by companies operating in the real sector of the economy. They own production assets and generate financial flows. It is recommended to refrain from assets pledged on loans. This is important because if an unfavorable scenario is realized, the procedure for negotiating loan restructuring is simplified. Experts recommend refraining from investing in junk bonds of IT companies, since their debt obligations exceed the size of the assets they have on the balance sheet. When investing in junk bonds, foreign issuers should give preference to high-yield bond indices. This will make it possible to better diversify the portfolio and minimize the risks caused by the probable default of the issuer.Is it worth investing in junk bonds and what is the yield on junk bonds: https://youtu.be/4Rfas4RGSEM Investors around the world prefer junk bonds, as highly rated instruments do not allow high returns. For example, ten-year US Treasury bonds generate an annual return of just 2.1%. And the average profitability of US junk bonds reaches 5.8% per year.