High-Yield Bond

When you think "low yield bonds," you think: safe. Secure. Sleep like a baby...even for Chicken Little bonds. The sky is not falling.

High yield bonds: Not safe. Not secure. The sky, among other things like credit ratings, is, in fact, falling.

Why do high yield bonds yield...a lot? That is, they pay a lot of interest to investors.

Because they have to. But why?

Because the bonds are risky.

Either the business is in danger of dying, or the business has borrowed soooooo much money that it's in danger of not being able to pay back the loans. That is, their operating profit is juuust barely enough to pay the interest costs on all the loans they borrowed, so the risk of default is high, and investors demand very high interest for taking on the risk of a potential bankruptcy.

The term “junk” was coined in the 1980s, when the now defunct investment bank Drexel Burnham Lambert sold boatloads of bonds that had dubious creditworthiness and weak backing.

And so the boatloads of bonds…sank. And ended up as basically…junk. Unlike your fancy "AAA" bonds, those junk bonds were riskier than swimming in shark-infested waters with a bloody nose.

So what's the best way to encourage people to do risky, possibly dangerous things? Pay 'em money.

That's why junk bonds yield such killer returns for investors...'cause otherwise these things would never leave the shelf.