Types of Bonds
High-Yield Corporate Bonds
Investing in High-Yield Bonds
The high-yield corporate bond market has grown rapidly, in part because these securities help meet the needs of a diverse array of investors. Some of the main attractions of the high-yield bond market for investors are:
- a high rate of current income associated with their high interest rates,
- the potential for capital appreciation if the debt is upgraded by one of the credit rating agencies, and
- precedence of legal rights over common and preferred stock in the event of the liquidation of the issuer, which affords some “cushion” of protection.
- High yield bonds are less affected by interest rates than other bonds are because they have higher yields and shorter maturities. (In general, interest rates are likely to change less over a shorter period.)
However, due to their credit quality, which is lower than that of instruments like UK gilts, US Treasury bonds or high-investment grade corporate bonds, high-yield bonds involve greater risk. You should evaluate whether the returns justify such incremental risks as:
- High-yield bond prices may decline in the event of a recession. Put another way, high yield bond prices depend more on the strength of the economy than high – grade bonds do.
- A bond may default if the issuer does not pay the interest or principal as required.
- A bond’s price may decline if the issuing company’s credit rating is lowered.
- A bond’s price may decline if interest rates rise.
- A bond’s price may decline because of unexpected news or financial results at the issuing company, or within the company’s industry.
An investor may have difficulty locating a buyer at certain times, as high-yield bonds can sometimes be “less liquid” than investment-grade bonds.