junk bond

Rubbish bonds are those bonds which are of low credit rating, wherein the issuer is in a very bad shape which may lead to the issuer being unable to make timely payments, or even being unable to pay back the principal.

These bonds are also known as ‘junk bonds’ and typically have higher yields than safer bonds as investors demand a higher rate of return to make up for the increased risk associated with them. These bonds are often issued by business entities or companies with weak financial condition, a high debt-to-equity ratio or have unstable earnings or cash flows.

In the 1970s, American business operator Michael Milken popularised these bonds and made them one of the most attractive instruments in the financial markets. Subsequently, ‘junk bonds’ had a huge decline in popularity due to many business entities declaring bankruptcy, as a result of issuing junk bonds with high yields.

Despite this decline in popularity, over the last few years junk bonds have experienced a resurgence. This is due to entities are looking for alternative sources for debt capital. As a result, governments, companies, municipalities and even some non-profits can take out loans from financial institutions at terms that offer high yields.

Even though high yields are attractive, investing in junk bonds isn’t without risk. They’re illiquid, have higher yields and may not have an active market, thus decreasing the probability of investors being able to sell them.

Moreover, interest payments may stop completely in case of a bankruptcy. Therefore, even though these bonds offer higher yields, prudent investors aren’t suggested to put more than 10%-15% of their investments in junk/rubbish bonds.

Junk/rubbish bonds are thus risky investments and come with the potential to make a great deal of money if done well but with the potential to lose a great deal of money if done incorrectly due to the risks associated with them. Careful research and an understanding of the associated risks should be done before investing in these bonds.

Garbage Bonds

Garbage Bonds are bonds referred to as junk bonds, high yield debt securities with a credit rating of BB or lower that offer investors a higher yield than bonds with a higher credit rating. Also known as non-investment grade bonds and speculative-grade bonds, they are sometimes also referred to as “fallen angels” if their rating has been downgraded from investment grade or “vulture investments” if they are distressed and potentially “toxic”.

Garbage bonds offer investors the opportunity to take on a greater risk for the chance at greater return, as their prices are strongly linked to the actual credit quality of their issuer and the prevailing market sentiment. The idea behind buying garbage bonds is that despite their low credit rating, they can still provide a much higher return than the average bond. While high yields may be attractive, the high risk they present could lead the prices of the bonds to fluctuate significantly, resulting in a potential loss of principal.

For this reason, many investors tend to shy away from investing in garbage bonds and prefer higher quality bonds. In addition, many mutual funds avoid buying these bonds, as it would significantly reduce the average quality of their portfolio. That said, some mutual funds and hedge funds specialise in these securities for maximum return, buying them in the hope that the issuer’s credit health will improve.

Overall, investing in garbage bonds is not for everyone and investors should approach any investment with caution, doing their own due diligence before taking on the risks these bonds present. While they may offer high returns if the issuer’s credit improves, they can also present the risk of significant losses. Therefore, investing a small segment of one’s portfolio in garbage bonds could potentially be a worthwhile strategy if one is knowledgeable and willing to take on the risk.