In terms of their structure, junk bonds are practically indistinguishable from any other bond. However, the difference is the financial health of the issuer. Often, junk bonds are issued by distressed companies in an effort to get some financing and try to turn their fortunes around. 

This leads to a lower than average score from credit rating agencies.

Typically, these are the credit scores awarded to junk bonds:

• BB or Ba: Bonds rated "BB" by Standard & Poor's (S&P) or "Ba" by Moody's are considered the upper end of the junk bond spectrum. While they are non-investment grade, they are considered to have a relatively lower risk of default compared to lower-rated junk bonds
• B: Bonds rated "B" by S&P or Moody's are further down the non-investment grade scale. They carry a higher risk of default than BB-rated bonds but often offer higher yields to compensate for the increased risk
• CCC or Caa: Bonds rated "CCC" by S&P or "Caa" by Moody's are at the lower end of the junk bond category. They are considered highly speculative and are associated with a significant risk of default. These bonds typically offer the highest yields but come with the greatest risk
• D: A "D" rating from both S&P and Moody's indicates that the issuer has already defaulted on its debt obligations or is in imminent danger of default

Characteristics Of Junk Bonds

While most junk bonds are quite similar to any other bond on the market, there are some key differences. For instance, many junk bonds do not qualify for trading on a major exchange and are instead traded on an OTC market, where investors directly buy and sell them from the issuer. 

The issuers of junk bonds are corporations with financial issues, with some of them having gone through bankruptcy courts and initiated restructuring proceedings to help turn the business around. 

Another point of difference is the yield. Junk bonds, due to an inherently elevated risk of default, have to offer higher yields to make them attractive to investors. 

Keeping track of individual junk bonds can be tedious, which is why Standard & Poor’s offers a high-yield bond index for investors to get an idea of how the junk bond market has been performing over a period of time. 

As we can see on the chart, the U.S corporate junk bond market has been steadily increasing over the past decade, which has been accelerated by interest rate hikes from the Federal Reserve to curb inflation. 

Risk Of Investing In Junk Bonds

Due to their high risk of default, investing in junk bonds is generally not advisable for beginner investors. However, aside from the inherent risk of default and market risks, there are other key factors that can make high-yield bonds an especially volatile investment:

• Liquidity Risk: Junk bonds may have lower liquidity compared to higher-rated bonds. During periods of market stress or when there is a lack of buyer interest, it can be challenging to buy or sell junk bonds at desired prices, potentially leading to wider bid-ask spreads
• Credit Downgrades: Junk-rated issuers may experience further credit downgrades, making it even riskier to hold their bonds. A downgrade can lead to a decline in bond prices and may result in forced selling by certain investors
• Covenant Risk: Some junk bonds may lack protective covenants that offer bondholders safeguards in the event of financial distress or restructuring. Without these covenants, bondholders may have limited recourse in challenging situations

• Junk bonds are fixed-income securities that have a low credit rating 
• Typically, junk bonds are issued by distressed companies with financial difficulties and sometimes bankruptcy proceedings
• Junk bonds are often traded on OTC markets, as opposed to major exchanges 
• Aside from market risk, junk bonds may also lack the covenants that offers bondholders some safety in the event of financial restructuring 
• Investors can track the performance of the U.S junk bond market by tracking the S&P U.S High Yield Corporate Bond Index