“Junk” bonds are non-investment grade bonds that offer higher yields to offset a higher default risk.
Investors may be looking for stronger returns with investment grade bonds recently producing low yields. Junk bonds’ devaluation risk, however, makes them unsuitable for the average investor.
Junk bonds have a high risk of devaluation.
When investors consider purchasing junk bonds through a broker, the broker must ensure that the bond meets the client’s investment goals and risk threshold. The broker must also adequately research the bond in order to present the investor with a complete benefit and risk assessment, and not misrepresent or omit material facts about the bond.
If you were advised to invest in a junk bond that lost money—and your broker did not meet their responsibilities—you may be able to file a claim for investment losses.
Bond Ratings
Bonds are essentially a loan between an investor and the bond issuer. Up until the bond maturity date, the issuer pays interest to the investor. When a bond reaches its maturity date, the issuer repays the investor the bond’s principal.
Bond ratings describe the creditworthiness of the issuer. The higher the bond rating, the lower the chance that the issuer will default. If an issuer defaults, the bond’s value decreases, and investors lose money.
Investors typically pay a higher price for higher-rated bonds, but quality bonds have a low default risk. Lower-rated bonds, in comparison, usually offer a higher yield as compensation for a higher default risk.
Most bonds are rated by at least one of the major ratings agencies, Moody’s and Standard & Poor’s. The two agencies’ ratings can differ somewhat.
The gold standard for investment bonds is U.S. government bonds, because the federal government can print money to pay its debts. U.S. agencies, state and local agencies, and corporations also issue bonds of varying quality.
Numerous factors, including interest rates and the issuer’s debt load, go into determining bond ratings. Since these factors are continually in flux as market conditions change, bond ratings, prices, and yields can vary over time.
Junk Bonds Are Not Suitable for All Investors
Bonds can help diversify your portfolio, but their benefits must be evaluated alongside their risks.
Junk bonds are particularly risky investments and in most cases are only appropriate for sophisticated investors with a high risk tolerance.
Junk bond losses may be recoverable.
Bonds issued by lower-rated companies are unsuitable for risk-averse investors. But some brokers recommend junk bonds to investors who do not have the ability or desire to withstand risk.
An investor who is willing to take a chance on junk bonds should receive a full evaluation of the bond’s risks and other characteristics from their financial adviser. Advisers who misrepresent or omit material facts about a bond that ends up causing investor losses may be legally responsible for those losses.
The Business Trial Group represents investors in junk bond securities litigation and arbitration on a contingency-fee basis. Contact us for a free case review.
