Glossary
Junk bond
The informal name for a high-yield bond: debt rated below investment grade that pays more for its higher risk of default.
A junk bond is a bond rated below investment grade: BB+ or lower at S&P Global and Fitch, or Ba1 or lower at Moody's. "Junk" is the market's blunt nickname; the industry's polite term is high yield or speculative grade. The issuers are companies with heavier debt, shorter track records or weaker businesses, and they pay higher interest to compensate lenders for a greater chance of not being repaid.
How the extra yield works
Investors judge junk bonds largely by their spread: the extra yield over a Treasury of similar maturity.
Junk bonds therefore behave partly like stocks: they tend to fall when the economy weakens and company profits come into doubt, rather than rising the way Treasuries often do in a downturn.
What to watch for
Default rates for high-yield debt rise sharply in recessions, and when defaults happen bondholders typically recover only part of their money. Many junk bonds are callable, so the issuer can repay early when rates fall, capping the price gain. The market is also less liquid than the Treasury market, so bid-ask spreads widen in stress. Some junk bonds began as investment grade and were downgraded; these "fallen angels" are a distinct part of the market. Most individuals get exposure through high-yield funds rather than single bonds.