Junk Bonds

Typical Junk Bond (photo)

This are bonds that are rated low by the official bond rating services, their quality ratings are BB or less. As a trade-off for their risk, junks pay higher yields than do top quality bonds, and often sell at a discount.

Even so, the risk of junk may be smaller than it seems. On average, fewer than one out of 100 companies that issue junk ever default. And you can lessen your chances of choosing that one loser if you diversify, by buying a bond mutual fund.

Look for a fund that in its name has the term "HIGH-YIELD" that means junk. Along with the yields, junks offer you a better chance for capital gains than do high rated issues. When interest rates drop, or bond ratings are upgraded, the prices of junk bonds often shoot up faster than do better quality issue.

When you shop for junk, you should distinguish between two type; genuine trust or quality junk. Bonds whose quality ratings have recently been downgraded are genuine trash. Pass them up. But other bonds maybe diamond in the rough. The companies that issue the bonds may be simply too young to have a long and favorable credit history.

In other cases, the ratings services may not all have recognized turnarounds in the issuing companies. And still other bonds may be quality junk because they are found in out-of favor lines of business, such as gambling. so you may do well by scouting for glitter amid the junk.

The far riskier type of trashy junk bond has been flooding the market. Many of this new debt issues are being used to finance corporate takeovers by outsiders or so-called leveraged buyouts by company insiders. Either way,many corporations are overburdened with more debt than they safely Can support.

If there is a recession or miscalculation by the deal makers, some of this corporations could take a dive and drag bondholders down with them. In a major bankruptcy, a defaulting junk bond could lose more than half its value overnight.

To be the safe side, avoid junk bonds issued in connection with such takeovers and buyouts. Some of them may be sound, but it's almost impossible for amateurs to evaluate. Also, diversify your holdings to reduce your risk.The best way is to invest in a corporate bond mutual fund that actively manages 70 to 140 issues.

Dealers and Brokers

Investors typically employ the services of dealers and brokers to execute the purchase and sale of securities. Some of these brokers are considered full-service brokers.

Full-service brokers provide a wide variety of services for the investor, including the provision of investment advice.

Other firms are considered discount brokers. Discount brokers basically provide the single service of executing the buy and sell orders of investors.

For mutual fund transactions the investor can deal directly with the mutual fund. Thus, the investor need not use the services of a broker or a dealer for these types of transactions.

Even in these instances, however, an investor may seek the advice of a financial adviser to determine which mutual fund to buy or whether to sell fund shares.

Value of Bonds

The value of bonds also will vary due to changes in the default risk, or credit rating, of bond issuers. If the issuer of the bond is unable to make timely principal and interest payments, the issuer is said to be in default.

Bonds issued by the U.S. government and by most federally related institutions are considered free of default risk. For other issuers, the risk of default is gauged by credit ratings assigned by four nationally recognized rating companies:

Moody's Investor's Service
Standard and Poor's Corporation
Duff & Phelps Credit Rating Company
Fitch Investors Service

Bonds that these rating companies place in the highest categories are known as investment-grade bonds. Bonds that are not assigned an investment grade rating are called junk bonds. These bonds have a higher degree of credit risk but also offer a higher potential yield.

Funds that aim for current income may be speculative, investing in high-yield, high-risk securities such as junk bonds, or conservative in outlook, investing in low-risk securities with a good record of paying dividends. Between the extremes are funds that are willing to take some risk for higher returns but are mindful of the need to conserve capital.

In general, younger investors, with most of their earning power ahead of them, can tolerate more risk than investors who are close to retirement.