junk bond
A high-risk, high-yield bond rated below investment grade (below BBB− by S&P or Baa3 by Moody's), issued by companies with weaker credit profiles.
Example
“Michael Milken became famous in the 1980s for using junk bonds to finance corporate takeovers.”
Memory Tip
Junk bond = corporate JUNK. Riskier companies offering higher rates to attract buyers.
Why It Matters
Junk bonds matter because they represent a trade-off between higher potential returns and significantly greater risk of default. Understanding this term helps investors make informed decisions about portfolio allocation and assess whether the extra yield compensates them for the possibility of losing their entire investment.
Common Misconception
Many people assume junk bonds are always a bad investment to avoid entirely, but experienced investors sometimes include them strategically in diversified portfolios to earn higher yields. The term junk is descriptive of credit quality, not necessarily a judgment that they should never be purchased.
In Practice
A struggling retail company might issue a junk bond offering 10 percent annual yield when government bonds pay only 4 percent. An investor who buys 10000 dollars of these bonds receives 1000 dollars yearly in interest, but faces real risk that the company could default and they lose their principal investment entirely.
Etymology
Colloquial American term popularized in the 1980s during the leveraged buyout era.
Common Misspellings
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Related Terms
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