High-yield Strategies
High-yield investment strategies attempt to earn interest or dividend rates significantly above the rates earned from safe investments, such as Treasury bonds or bank certificates of deposit. Along with higher yields come higher risks of loss of principal. Investors using a high-yield strategy must perform extra research and monitor the investments for any changes that could negatively affect investment values.
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Non-Investment Grade Bonds
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Non-investment grade bonds are often referred to as high yield or "junk" bonds. High-yield bonds are debt securities with credit ratings below what is considered to be investment grade. To borrow money through bonds, corporations with lower credit ratings pay a significantly higher rate of interest than issuers with investment grade ratings. From 1987 through 2010 the average yield spread of high-yield bonds over Treasury bonds was 4.7 percent. Investors can best invest in high-yield bonds through high-yield mutual funds or closed-end funds.
Leveraged Bond Funds
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A leveraged bond fund earns a high yield by financing the purchase of investment grade bonds with money borrowed at lower interest rates. For example a fund manager buys $10 million of bonds paying 6 percent and borrows $5 million at 3 percent to fund part of the purchase. The investment costs $5 million, the fund earns $600,000 in interest and pays $150,000 in interest on the borrowed money. The yield becomes $450,000 on $5 million or 9 percent. Leverage bond funds are almost exclusively closed-end funds. The Closed End Fund Association website lists more than 100-taxable and tax-free bond funds that use leverage. The danger of leveraged bond investing is rising short-term rates, squeezing the spread the fund earns with borrowed money.
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High-yield Stocks
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High-yield stocks are those that pay dividends providing yields well above the rate earned on low-risk, fixed-income securities. High-yield stocks can be found in the energy, telecommunications, real estate and transportation sectors. The companies behind high-yield stocks are often organized under tax laws that require the majority of income to be paid out as distributions to investors. Stock dividends are not guaranteed and an investor looking at high-yield stocks should study a company's dividend payment history and understand how the business generates revenue and what factors could cause the dividend to be reduced.
Covered Call Writing
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Covered call writing involves buying shares of a selected stock and selling call options against the shares. The money received for the call options becomes the income earned from the strategy. If the strategy works correctly, covered call writing can generate total returns of 12 percent to 20 percent per year. Writing covered calls works if the purchased stocks stay level or increase in value. If the stocks purchased decline in value, writing covered calls will be a money losing strategy.
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References
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