The market for High yield bonds grew rapidly in the 1990s, partly because these securities meet the needs of a wide variety of investors. Some of the main attractions of the high yield bond market for investors are:
- a high rate of current income combined with their high interest rates,
- the potential for capital appreciation if the debt is upgraded by one of the rating agencies, and
- Precedence of statutory rights over common and preferred shares in the event of the issuer's liquidation, which offers a certain “cushion” of protection.
Because of their credit quality, which is lower than that of instruments such as US Treasuries or high-quality corporate bonds, high yield bonds are associated with higher risk. You should evaluate whether the returns warrant such incremental risks as:
- High yield bonds can plunge in the event of a recession.
- A bond can default if the issuer does not pay the interest or principal as required.
- The price of a bond can fall if the creditworthiness of the issuer is downgraded.
- The price of a bond can go down when interest rates go up.
- The price of a bond may decrease due to unexpected news or financial results at the issuing company or within the company's industry.
- An investor may have difficulty finding a buyer at certain times as high yield bonds can sometimes be “less liquid” than investment grade bonds.
The benefits and risks for the investor are explained in more detail later.