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Junk Bonds: Advantages and Disadvantages

Investing comes with risk, but sometimes, that risk is just a necessary hurdle for significant financial gains. One of the best examples to illustrate this is junk bonds. Junk bonds are high-risk and high-return corporate bonds. They are usually categorized as non-investment grade because of various reasons, such as the following:

  • The company that owns the bonds is not financially stable
  • The company may not be able to sustain payments if business and economic conditions falter
  • The company is alarmingly vulnerable to opposing conditions

Advantages

Like other commodities, junk bonds have advantages and disadvantages. The most obvious advantage is the fact that they can yield high returns. Of course, it is important to note that to get those high returns, investors should be aware that they have to overcome the high risks as well. But when they do, they are sure to get significantly higher points compared to other commodities.

Second, the value of the bond has a chance to spike up, especially if the company has improved its credit rating. This is particularly true for companies who have suffered from unfair credit ratings from the past, because you can feel the spike even more.

Third, it can also be argued to be better than stocks when it comes to high-risk investments. This is because bondholders are paid first before stockholders, so you can still get something back if the company goes down the drain.

Disadvantages

The most obvious disadvantage of junk bonds is the fact that it is high risk, in the sense that you can actually lose money especially when there is a default. Another disadvantage is related to the credit advantage mentioned earlier, because credits go both ways. If the credit rating of the company deteriorates, so is the value of the bond. This idea can also be applied on interest rates, in the sense that a rise in the interest rate results into the fall of bond value.

So many people have lost money because of junk bonds because of these disadvantages. According to the website of Erez Law, brokerage firms and financial advisors may be held liable for this, especially if the investment has been discovered to be unsuitable for the investor’s status.