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What Individual Investors Need to Know About Junk Bonds

March 24, 2016 Blog

As an individual investor, bonds are likely an important part of your investment portfolio. Bonds provide diversification, and they can also provide greater certainty with regard to investors’ expected returns.

However, like other types of investments, some bonds are safer than others. The riskiest types of bonds are known as “junk bonds.” While junk bonds pay higher interest rates, they also carry the greatest risk that investors will lose their principal and be left with nothing.

While the standard advice holds true (always consult with your investment advisor and understand the risks before investing in junk bonds), junk bonds deserve an extra word of caution. This is because: (i) quality bonds can turn into junk bonds if a company underperforms, and (ii) many times investors do not realize that their advisors are investing in these high-risk opportunities.

What is a Bond?

A bond is a loan made to a corporation in exchange for the payment of interest. Just like you owe interest when you borrow money to buy a house or a car, corporations owe interest when they borrow money from investors to grow their businesses. Bonds have pre-determined interest rates, so investors generally know what to expect in terms of the return on their investment.

What is a Junk Bond?

Fundamentally, a junk bond is no different from any other type of corporate bond. The difference lies in the credit rating of the company taking out the loan.

Companies that borrow money from investors receive credit ratings from various rating agencies. These ratings are based on a number of complex factors, but are designed to provide investors with a basic snapshot of the financial standing of the companies that are issuing bonds. Corporate credit ratings fall into two broad categories:

  • Investment Grade – An investment-grade rating generally means that the company is financially sound and is relatively unlikely to default on investors’ bonds. Since these companies’ bonds are more attractive, the interest rates they offer are generally lower.
  • Junk Bonds – Bonds that are not investment grade fall into the “junk” category. Companies that issue junk bonds are often unable to raise capital through other means, and as a result must offer higher interests rates in order to attract investors.

What are the Risks Associated with Junk Bonds?

Since companies that issue junk bonds are in poor financial standing, investors run the risk that these companies will spend their money and not only be unable to pay interest, but also be unable to return the investors’ principal (the amount they originally invested). With bond funds, this can result in substantial investment losses.

In many cases, individual investors who lose money in junk bond investments made through broker-dealers can file claims to recover their losses. If you suffered losses in junk bonds or a bond fund, we invite you to contact us to learn more.

Zamansky LLC | Lawyers Representing Investors with Junk Bond Losses Nationwide

At Zamansky LLC, we provide experienced legal representation for individual investors who have lost money in junk bonds. To find out if you may be eligible to recover your losses, please call a junk bond lawyer at (212) 742-1414 or request a free confidential consultation online today.