A bond that is rated below investment grade (a rating of BB or lower) due to its bad credit quality. This pejorative connotation implies that this bond carries a much higher default risk than do investment-grade bonds, but it also offers a higher yield. However, a higher promised yield may not result in a higher realized return because the higher yield reflects a higher expected likelihood that the issuer will default on principal and interest payment during the bond’s life.
Junk bonds are usually issued by firms that lack a long track record of earnings or by those whose credit strength is shaky or questionable. In the 1980s, junk bonds were a fashionable means of financing takeover deals. Historically, most of the sub-investment grade bonds trading in the market were given investment-grade ratings at time of issue but later fell to junk status.
Junk bonds are also known as high-yield bonds.
