||Ask the Dollar Diva
Truth about junk bonds
Dear Dollar Diva,
What is a junk bond?
A junk bond is issued by a corporation or municipality
with a bad credit rating. In exchange for the risk of lending money
to a bond issuer with bad credit, the issuer pays the investor a
higher interest rate. "High-yield bond" is a nicer name for junk
What is a bond?
When a corporation or municipality borrows money from
an investor, it gives the investor a bond. The bond is like an IOU
or promissory note -- it states the amount that will be paid back,
when it will be paid back, and what interest will be paid on the
borrowed money. Bonds come in two grades:
- Investment grade bonds: Those that Standard
& Poor's and Moody's rate as carrying no more than medium risk
and at least medium quality.
- Junk bonds: Those with high risk and below
medium quality, and those in default.
How do I know if a company or municipality has
a bad credit rating?
Standard and Poor's and Moody's are the bond-rating
systems used most often by investors. Their ratings are as follows:
||Lowest risk/highest quality
||Low risk/high quality
||Low risk/upper medium quality
||Medium risk/medium quality
||High risk/low quality
|Caa, Ca, C
||CCC, CC, C
||Highest risk/highly speculative
Should I buy junk bonds?
Never buy individual junk bonds because they are too
risky. However, a high-yield bond fund can be a good addition to
your portfolio if you do all of the following:
- Hold it for more than five years
- Reinvest the income
- Hold it in a tax-deferred account (IRA, 401(k))
- Make this holding a very small part of your
portfolio. No more than 20 percent of your bond money should be
in junk bonds
-- Posted: Jan. 5, 2000