Junk Bonds

An investment entitled "junk" anything should cause a warning flag to pop up. Why would bonds be called junk? Let's walk through what junk bonds actually are and see if they live up to their label.

Of the various types of bonds, junk bonds are simply those issued by corporations that are considered high-risk. This means that bond rating services such as Standard & Poor's and Moody's Investors Service have assigned them a low rating in terms of the company's ability to meet its obligations. So why would anyone invest in these bonds? To offset the risk involved, these bonds offer higher interest rates than other corporate bonds.

Is the higher interest rate paid worth the risk? The answer is that it depends. The risk may be worth it if a company looks promising, but is too young to have an established a record, as opposed to having a bad history. On the other hand, if the company issuing the junk bond has poor growth and low profits or a lot of debt, chances are good that the risk is one you shouldn't chance.