What are Junk Bonds?
A junk bond is a high-risk bond that is rated BB or lower by one of the main ratings agencies. There is a reasonably high risk that the issuer of the bond will default on the payments, hence the low rating. Junk bonds usually pay a high rate of interest. There are two reasons for purchasing junk bonds. The first option is for speculation purposes, going on the assumption that the issuer is more credit-worthy than they are being given credit for and that they will actually meet the high payments. The other strategy is to purchase a large amount of diverse junk bonds and assume that only a few will default, but that the high return by the ones which succeed will more than outweigh the defaulting ones. Junk bonds became very popular in the 1980s through the work of Drexel Burnham Lambert and Michael Milken.