Introduction

High-yield bonds, often referred to as “junk bonds,” are a unique category of corporate bonds that offer higher yields to investors in exchange for taking on increased risk. These bonds are issued by companies with lower credit ratings, indicating a higher likelihood of default compared to investment-grade bonds. In this chapter, we will delve into the definition of high-yield bonds, explore the types of issuers that commonly issue these bonds, and discuss the distinctive payment features that set high-yield bonds apart from their investment-grade counterparts.

Definition of High-Yield Bonds

High-yield bonds are debt securities issued by companies with credit ratings below investment grade (typically rated below BBB- by major credit rating agencies such as Moody’s or Standard & Poor’s). These bonds offer higher interest rates compared to investment-grade bonds to compensate investors for the increased credit risk associated with the issuer.

Types of High-Yield Bond Issuers

Several types of issuers are commonly associated with high-yield bonds:

• Start-Up and Growth Companies: Start-up companies and those in a growth phase might lack the established financial stability of larger corporations, making them more likely to issue high-yield bonds to fund their expansion. These companies often promise higher potential returns to attract investors.

• Companies in Distressed Situations: Businesses facing financial difficulties, restructuring, or turnaround efforts might rely on high-yield bonds to raise capital during challenging times. These companies are considered riskier investments due to their precarious financial positions.

• Sectors with Cyclical Nature: Industries that experience cyclical performance, such as commodities or energy, might issue high-yield bonds due to the inherent volatility of their revenues and earnings. The bonds’ higher yields compensate investors for the sector’s unpredictable fluctuations.

Unique Payment Features of High-Yield Bonds

High-yield bonds come with distinctive payment features that reflect the issuer’s higher credit risk:

• Coupon Payments: High-yield bonds offer higher coupon payments compared to investment-grade bonds. The coupon rate compensates investors for the heightened credit risk of the issuer.

• Call Provisions: Just like investment-grade bonds, high-yield bonds can have call provisions that allow the issuer to redeem the bonds before maturity. However, due to their riskier nature, high-yield bonds often have more favorable call terms for issuers.

• Covenants and Restrictions: High-yield bonds may include stricter covenants and restrictions to protect bondholders’ interests. These provisions aim to ensure that the issuer maintains certain financial ratios or limits certain actions that could jeopardize bondholders’ returns.