High-Yield Bond
Key Highlights
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A High-Yield Bond is a fixed-income security issued by a company with a lower credit rating than investment-grade issuers.
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High-yield bonds are also commonly referred to as below-investment-grade bonds or speculative-grade bonds.
What is High-Yield Bond?
A High-Yield Bond is a fixed-income security issued by a company with a lower credit rating than investment-grade issuers. Because of the higher perceived credit risk, these bonds offer higher interest rates (yields) to compensate investors for the increased probability of default.
High-yield bonds are also commonly referred to as below-investment-grade bonds or speculative-grade bonds.
Why Companies Issue High-Yield Bonds?
Companies may issue high-yield bonds to:
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Raise capital when investment-grade funding is not available
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Finance expansion, acquisitions, or restructuring
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Refinance existing debt under flexible covenants
For issuers, high-yield bonds provide access to capital markets despite elevated risk profiles.
Benefits of High-Yield Bonds
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Higher Income Potential: Offer higher coupon rates compared to investment-grade bonds, enhancing portfolio yield.
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Attractive Risk Premium: Credit spreads compensate investors for taking on additional credit risk, especially during stable economic conditions.
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Portfolio Diversification: Provide diversification benefits when combined with government securities and investment-grade debt.
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Return Opportunities from Credit Improvement: Bonds may deliver capital gains if the issuer’s credit profile strengthens or ratings improve.
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Access to Growth-Oriented Issuers: Enable participation in companies that may be in expansion, restructuring, or turnaround phases.
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Active Management Advantage: Skilled credit selection and monitoring can help optimise risk-adjusted returns.
Key Risks Associated with High-Yield Bonds
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Higher Default Risk: Issuers typically have weaker financial profiles, higher leverage, or limited operating history, increasing the likelihood of credit events.
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Economic Sensitivity: High-yield bonds are more exposed to economic cycles and tend to underperform during periods of slowdown or financial stress.
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Interest Rate and Spread Volatility: Returns can be impacted by changes in interest rates as well as widening credit spreads.
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Sector Concentration Risk: Exposure is often higher to cyclical or capital-intensive sectors, making performance sensitive to sector-specific developments.
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Liquidity Risk: Secondary market liquidity may be limited, particularly during volatile or stressed market conditions, leading to wider bid-ask spreads.
FAQs on High-Yield Bonds
1. Are high-yield bonds the same as junk bonds?
“Junk bond” is an informal term. The correct professional term is high-yield bond.
2. Are high-yield bonds suitable for conservative investors?
Generally no. Due to higher default and volatility risks, they are more suitable for investors with higher risk tolerance.
3. How do high-yield bonds perform during economic downturns?
They tend to underperform during downturns as credit spreads widen and default risk increases.
4. Do high-yield bonds always offer higher returns?
Not always. While yields are higher, returns depend on issuer performance, credit events, and market conditions.
5. How do high-yield bonds differ from investment-grade bonds?
High-yield bonds carry lower credit ratings and higher yields, while investment-grade bonds offer greater stability but lower income.