Junk Bond (High-Yield Bond)
A junk bond is a bond rated below investment grade, meaning a higher risk of default, which pays a higher yield to compensate investors.
Bonds rated below BBB- by S&P and Fitch, or below Baa3 by Moody's, are considered speculative grade. The industry calls them high-yield bonds; the informal name is junk bonds. Issuers include young companies, highly indebted firms and former investment-grade companies that were downgraded, known as fallen angels.
The higher coupon is compensation for risk. Default rates on high-yield bonds are much higher than on investment-grade debt and tend to rise sharply in recessions. When a default occurs, investors often recover only part of their principal.
Junk bond prices often behave more like stocks than like Treasuries. They can fall when the economic outlook worsens, even if interest rates are dropping. Investors often follow the high-yield spread, the extra yield over Treasuries, as a gauge of market stress.
Example: a company rated BB might pay a 7% coupon when a comparable Treasury yields 4%, reflecting a spread of 300 basis points.