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When you buy a
bond, you are lending your money to someone (the government or a private
company) who promises to pay you back the money when the bond matures, plus
interest. The ability of the bond issuer to meet its obligation is
expressed in the bond's credit rating. Whether a company defaults
on its bonds or not depends on its ability to pay back its debt.
Bonds that have a high credit rating are known as
investment-grade bonds. Bonds that are likely to default are called
speculative or non-investment grade. Low-grade bonds may be
issued by companies without long track records, or with questionable ability to
meet their debt obligations. Because most brokers do not invest in these
low-grade bonds, they are known as junk bonds. However, because of
the very high interest rates these bond issues typically offer, they are also
referred to as high-yield bonds.
Because junk bonds have a high default risk, they are
speculative. Default risk is the chance a company or government
will be unable to pay its obligations when the bonds mature. Defaults
on bonds most often occur within the first several years of a bond's issue.
Even when a junk bond defaults, it might still keep some of its
value. The impact of a default on a bond's price is known as its
default loss rate. Sometimes a bond's actual price loss is not the
same as its rate of default loss. A default due to bankruptcy will
probably reduce a bond's price more than a default due to a company changing its
strategic direction. |
