How to Buy Junk Bonds

A junk bond is just like any other bond in that it is an IOU from a government or corporation that states how much it will pay you back (the principal), with what percent interest (the coupon rate) and the date it will pay you back (the maturity date). Junk bonds are different from other bonds in that their issuers have low credit ratings. People invest in junk bonds because they pay higher interest than bonds with high ratings, even though the risk is greater.

Instructions

Difficulty: Moderately Challenging

Evaluate Your Risk Tolerance

1. Make good use of the fact that companies with poor credit ratings have to pay higher interest rates than those with good credit ratings. Therefore, junk bonds pay investors better interest rates than investment grade bonds.
2. Gain higher profits by taking a chance. There is a greater chance that these companies will default on the bonds because they are unable to pay back the principal. That makes it a riskier investment than regular bonds. Yet the prices on junk bonds are often low, making the yield (the interest rate divided by the price of the bond) higher.
3. Minimize your risk with junk bonds by diversifying your portfolio. A portfolio that has a mixture of high and low risk securities offers some protection against losses. Including some junk bonds in a balanced portfolio could raise its overall value.
4. Evaluate your risk. Junk bonds are broken into two categories: fallen angels and rising stars. Fallen angels are bonds that were once investment grade but fell because their issuers' credit ratings dropped. Rising stars are bonds whose issuers' credit ratings are rising. These bonds are on their way to becoming investment quality. Use this information to evaluate junk bonds before you decide to buy them.
5. Speak with your broker or other financial advisor to buy junk bonds and investment grade bonds. She can also help you buy other securities.

Tips & Warnings

• Avoid buying junk bonds if you are investing to get a fixed income with regular interest payments. Not only are junk bonds vulnerable to default, they are also more influenced than other bonds by boom and bust cycles.
• Avoid buying junk bonds if you have a low tolerance for risk. Junk bonds are riskier investments than other bonds because their issuers have low credit ratings. Some experts consider them to be suitable only for gamblers and speculators.
• Have considerable analytical skills and knowledge of the market in order to buy junk bonds.