What is a junk bond?
In: Economics
[removed]
Bonds are basically when you loan money to a govt entity or corporation. They pay you back with interest over time, so you make money in the long run. Junk bonds are basically loaning money to a govt entity or corporation who either can’t pay you back or will pay you back at such low interest it’s not worth your time.
So, bonds are for loaning money to the issuer who promises to repay the money at a specific date. Investors can make annual interest off of them. A junk bond is when the bond or the underlying company of the bond is at risk of defaulting. Junk bonds typically come from failing business or startup businesses in order to raise money quickly.
Bonds have ratings, like people have credit scores. There is an arbitrary line between a Baa3 / BBB- rating and a Ba1 / BB+ rating. If you’re above, you’re considered an “investment grade” (IG) company, if you’re below you’re “high yield”, (HY) or “junk”. Note that the term junk is very dated, nobody in the industry uses it anymore.
There are four main differences between IG and HY bonds:
1) the costs – HY borrowers have to pay a higher interest
2) the buyers – bond investors often have restrictions on how many junk bonds they can buy, so there are far fewer buyers of junk bonds vs HY bonds
3) the covenants – HY bonds typically have more restrictive terms that prevent the company from doing something that harms its creditors
4) the availability – during a market crash, HY companies cannot raise additional capital. So for example for the past two weeks IG companies have borrowed more money than ever before, but very few high yield companies have managed to sell new bonds
Bond is basically a loan given to a company, in which they pay you interest. Lets say you OP have $1000 and give say give a new company the money.
Basically you will then make a bond which has like terms, e.g. Pay me back the money in 30 years time at 10% interest per year. Some crazy shit like that, now basically the more estabilished the company is the lower interest rate you can give. So government bonds for example have the lowest interest as the government tends to be really stable.
Now a junk bond is basically giving money to a shit company and charging them a high rate. It’s called a junk bond because these companies are risky af.
So why even give these pieces of shit money? Simple, say the conditions were 10% for 30 years. And now these companies are making tonnes of money and have become really big. They’ll still be giving you 10% whereas other people will only be getting like 1% interest off them (they’re big and stable now, they don’t need to get charged high interest).
And yeah there you go. My ELI5 of junkbonds
Latest Answers