Junk bonds

Junk bonds are also known as ‘high yield’, ‘non-investment grade’, or ‘speculative’ bonds. They are usually issued by companies without well-established records of earnings, and so have to offer higher rates of interest to compensate for a greater probability of default on those interest payments.

The rating is determined by the main credit rating agencies: Moody’s, Standard & Poor’s, and Fitch. Junk bonds are also used by small firms to finance takeovers of larger companies, particularly in the US. Firms with investment grade (BBB- or better, according to S&P’s system) bonds can be downgraded to junk status if they hit difficulties. These are called ‘fallen angels’.

• See Tim Bennett’s video tutorial: Bond basics.