Junk Bond. Silly term heard on the news before sitting down at the table for dinner. What is it about?
Bond means debt. Government Debt. The term junk in this case stands for garbage, something that should be thrown away.
But when we talk about junk bonds, at the moment we are talking about something very “popular”.
With junk bonds we describe high-yield bonds, a yield given by their high risk.
It should be understood that higher the risk of lending money to a company or a country that could be insolvent, the higher the return for the lender must be.
When you go to lend money to risky companies by buying their securities, you are entering a risky business.
These companies may be in some risky businesses or economic sectors or they just have too many debts due to bad management or moments of crisis. By investing in this risk you will end up having big interest at the end of each year or month, depending on the instrument chosen.
Unfortunately, however, if these companies are badly managed you may have some small economic satisfaction at the beginning and then end up losing your capital.
Or on the other hand, these companies are well managed, you will have an excellent return and then get all your investment back.
High Yields companies create bonds that are risky and therefore are considered with a very low rating, therefore with a very high yield on the contrary, the so-called investment grade bonds that have a very good rating score have a lower yield.
But what does Yield mean?
Let’s see how the yield of a debt security works like a normal corporate bond, we are not talking about Junk Bond and the figures entered here are by way of example.
let’s assume that Luca buys a 100 euro bond from GoGA GMBH, with an annual yield of 5%
So Luca lends 100 euros, and in exchange he has a piece of paper that says that he has lent 100 euros to the GoGa and that at the end of the year at the end of the bond he will receive 100 euros plus 5 euros of interest
the 5 euro of interest is the gain of the financial product and therefore the coupon yield on this bond is defined.
but what happens if luca decides to sell the bond before its maturity
if he sells the bond at a price below 100 (which is the base price of each bond), let’s assume 95.
sells the bond to Marco. Marco expires the bond and then receives 105 from the company, so Marco’s yield becomes 10 and no longer 5 as in the case of luca
as the bond price falls, the yield increases
on the contrary, if Marco buys the bond at 101, his yield will be only 4, with a decrease in the yield.
this is the basis of how yield works