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Are Junk Bonds for You

2012-02-01 07:30
As we have seen in earlier posts, a bond is a loan made to a government or corporation with the borrower obligated to pay back the principal with interest at maturity. The creditworthiness of the borrower (bond issuer) is reflected in the bond 8217;s credit rating; the better the ability of the issuer to meet their debt obligation, the higher the credit quality of the bond. Bonds with superior long-term credit ratings (AAA, AA+, AA, etc.) are known as prime or high-grade bonds. These bonds are issued by companies with a solid track record and the high rating is a testament to the issuer 8217;s ability. On the contrary, there are some corporations that have a poor record of meeting their debt payments (whether late or default) or do not have a long history but still need money to finance their activities. Since investors would be unwilling to part with their cash for such a corporation 8217;s bond, the company will have to lure investors through their high bond interest rates. Due to the speculative nature of such bonds, they are calledВ junk bonds or, to put a positive spin, high-yield bonds. Usually, the credit rating of such junk bonds are BB, B+, B-, CCC, etc. to reflect the potential risk of default. Junk bonds in the current interest rate environment Until a few years ago, the Canadian junk bond market was virtually non-existent after it went into a dormant state in 1990 and companies sought refuge in the established US junk bond market. However, due to the current low interest rate environment, a few companies have started borrowing in Canada by issuing junk bonds; a short list of junk bond issuers is available here (second page of above link). A point of note for junk bonds is the yield spread; in other words, the difference in yield between a junk bond and government debt. The yield spread is important as it helps in identifying whether the reward (higher yield) outweighs the risk (default). Junk bond ETFs As with other asset classes, junk bonds are also available as ETFs to help mitigate the impact of default that gains focus when buying a few individual junk bonds. iShares iBoxx High Yield Corporate Bond Fund (ticker: HYG), SPDR Barclays Capital High Yield Bond Fund (ticker: JNK), and PowerShares Fundamental High Yield Corporate Bond Fund (ticker: PHB) are some of the options available to investors interested in going this route. A short list of high-yield junk bond ETFs is available at ETFdb. As the stock markets alternate between fear and confidence, the market rallies have fueled the performance of such junk bond ETFs. Nonetheless, the pickings seem slim in the Canadian junk bond category with the AGF Canadian High Yield Bond Fund being the prominent player. Similar to other bond ETFs, it would be useful to look at the liquidity, expense ratio, default rate, yield spread, fund composition, and direction of the fund (strategic changes) when looking to invest in junk bond ETFs. Are junk bonds for the average investor As should be ev...
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