Record low interest rates are pushing a rising number of investors to junk bonds
Since the financial crisis struck, across the world interest rates fell to try to keep the global economy ticking over.
But record low interest rates mean that investors are struggling to get a decent return on their cash. One of the biggest beneficiaries of this are junk bonds.
So why are investors turning to junk bonds? And what are the risks of investing in junk bonds?
Let's take a closer look…
What are junk bonds?
are bonds that have a credit rating of less than BBB from a credit rating agency like Standard & Poor’s or Moody’s.
Junk bonds also go under the name of high yield bonds, speculative grade bonds and sub-investment grade bonds.
These bonds offer investors higher yields (interest rates) than investment grade bonds. But with the offer of higher yields comes higher risk, Cris Sholto Heaton in Money Week
With investors seeking decent returns, the number of investors venturing into junk bonds has grown over the last few years, in spite of the risks.
What are the risks of investing in junk bonds?
When you invest in bonds and hold them until maturity, there are three factors determining your return:
The interest rate you receive;
The default rate; and
The recovery rate (how much you get if one of the bonds defaults).
When you buy bonds, you usually know the interest rate you’ll receive over the life of the bond. But when it comes to default rates and recovery rates, you can only look at what’s happened historically.
Investing in junk bonds may look attractive if you look at the interest rate alone. But you have to remember there is a reason for the interest rate being much higher than with say government bonds.
There is a higher level of risk attached. And that risk stems from the chance of a default and not getting your original investment back.
So there you have it, why record low interest rates are pushing a rising number of investors to junk bonds.
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