01
Issuer Raises Capital
A company or organization issues bonds to borrow money from investors for business operations, refinancing, expansion or other purposes.
HIGH-YIELD BONDS
High-Yield Bonds and How They Work
High-yield bonds can offer higher income than many investment-grade bonds, but that additional yield comes with greater credit and market risk. Understand how they work, why yields are higher, and what to consider before investing.
HIGH
YIELD
Higher Yield
Credit Risk
Fixed Income
UNDERSTANDING HIGH-YIELD BONDS
What are high-yield bonds?
High-yield bonds are debt securities issued by companies or other organizations that have lower credit ratings than investment-grade issuers. Because investors take on greater credit risk, these bonds typically offer higher interest rates to compensate for that risk.
They are also commonly called junk bonds. The term describes their credit quality rather than suggesting that every issuer is likely to default. High-yield bonds can include companies with different financial profiles, industries, maturities, and capital structures.
For investors, the important question is not simply how much interest a bond pays. The potential income needs to be considered alongside default risk, interest-rate movements, market liquidity, and the financial strength of the issuer.
Why the yield is higher
Higher interest rates generally reflect the additional credit risk investors accept when lending to lower-rated issuers.
HOW THEY WORK
Higher yield usually comes with higher risk.
Understanding the relationship between bond prices, interest rates, credit quality and yield is essential when evaluating high-yield debt.
02
Investors Receive Interest
Bondholders generally receive interest payments according to the coupon and payment schedule established by the bond.
03
Credit Quality Matters
Lower credit ratings generally indicate greater perceived difficulty in meeting debt obligations and can lead to higher required yields.
04
Market Value Changes
Before maturity, the bond's market price can change as interest rates, credit conditions and investor expectations change.
YIELD AND CREDIT QUALITY
The extra income reflects extra credit risk.
Bond yields are influenced by the compensation investors require for taking on different types of risk. When a borrower's credit profile is weaker, investors may demand a higher yield.
That higher yield can make high-yield bonds attractive during certain market conditions, but the relationship works both ways. A deterioration in an issuer's finances can push its bond price lower and increase the possibility of default.
Credit quality
Interest rates
Default risk
POTENTIAL BENEFITS
Why investors may consider high-yield bonds.
High-yield bonds can serve a specific role in a diversified portfolio, particularly for investors seeking income and willing to accept additional credit risk.
Higher Income Potential
High-yield bonds generally offer higher coupon rates than comparable investment-grade debt because investors take on greater credit risk.
Portfolio Diversification
High-yield debt can provide a different source of fixed-income exposure compared with government and investment-grade bonds.
Potential Return Opportunity
Changes in credit conditions can affect bond prices, creating the possibility of price appreciation as well as income.
RISKS TO UNDERSTAND
Higher yields come with meaningful risks.
The higher income offered by high-yield bonds should always be evaluated alongside the possibility of losses and changing market conditions.
Default Risk
An issuer may fail to make scheduled interest or principal payments, potentially resulting in losses for bondholders.
Credit Risk
A deterioration in an issuer's financial position can reduce the value of its debt and increase the risk premium investors demand.
Interest-Rate Risk
Changes in market interest rates can affect the price of bonds sold before maturity.
Liquidity Risk
Some high-yield securities may be harder to sell quickly at an attractive price during stressed market conditions.
Economic Risk
Weak economic conditions can put pressure on companies' earnings, cash flow and ability to service debt.
Market Volatility
High-yield markets can experience larger price swings when investors become more concerned about credit conditions.
COMPARING BONDS
High-yield vs investment-grade bonds.
Both can play a role in a fixed-income portfolio, but their risk and return characteristics can be quite different.
Factor
Investment-Grade Bonds
High-Yield Bonds
Credit Quality
Generally higher credit ratings
Generally below investment grade
Potential Yield
Generally lower
Generally higher
Default Risk
Generally lower
Generally higher
Price Volatility
Can be more moderate
Can be more sensitive to credit conditions
Income Focus
Income with emphasis on credit quality
Higher income potential with additional risk
BEFORE YOU INVEST
What to check before buying high-yield bonds.
Looking beyond the coupon rate can help you better understand the potential risk and return of a high-yield investment.
Review the Issuer
Look at the company's financial position, debt levels, cash flow and ability to service its obligations.
Check the Credit Rating
Understand the assigned credit rating and how it compares with other bonds you are considering.
Compare the Yield
A higher yield can reflect higher risk, so compare yield with credit quality and maturity.
Understand Maturity
Consider whether the maturity fits your financial goals and expected holding period.
Consider Liquidity
Review how easily the bond can potentially be sold before maturity and the possible impact of bid-ask spreads.
Think About Diversification
Avoid concentrating too much portfolio exposure in one issuer, industry or credit segment.
LOOKING BEYOND THE YIELD
A higher coupon is only part of the investment picture.
High-yield bonds can provide attractive income, but the headline yield should not be viewed in isolation. Investors need to consider the issuer's ability to repay its debt, current market conditions, interest rates and the price paid for the bond.
A diversified approach can help investors avoid relying too heavily on one company or one area of the high-yield market.
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FREQUENTLY ASKED QUESTIONS
Questions about high-yield bonds.
High-yield bonds are debt securities issued by borrowers with lower credit ratings than investment-grade issuers. They usually offer higher interest rates to compensate investors for greater credit risk.
Yes. High-yield bonds are commonly referred to as junk bonds. The term refers to their below-investment-grade credit rating, not necessarily the quality of every individual issuer.
Investors generally demand greater compensation for accepting higher credit and default risk. This can result in higher interest rates compared with investment-grade bonds.
Yes. Their market prices can decline because of changing interest rates, deteriorating credit conditions, economic weakness or other market factors.
They can provide a different source of fixed-income exposure, but their higher credit risk means they should be considered within the context of an investor's overall asset allocation.
Review the issuer's financial strength, credit rating, yield, maturity, liquidity, debt structure and how the investment fits within your overall portfolio.
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