humburger
Blogs

Junk Bonds in India: Meaning, Benefits, and Should You Invest?

In the diverse world of investing, junk bonds stand out as a unique opportunity. These high-yield bonds offer investors the chance to earn higher returns than most traditional bonds. But with higher returns come higher risks. For investors who understand these risks and rewards, junk bonds can play an important role in building a balanced portfolio. Knowing the junk bond meaning helps you make informed decisions and see how these bonds fit your financial goals. With the right knowledge, junk bonds can add valuable diversity to your investment strategy.

What are Junk Bonds? 

Think of a business that’s just starting out or one that’s carrying a lot of debt but needs funds to grow or restructure. These companies often issue junk bonds to raise money. Unlike investment-grade bonds issued by financially stable companies, junk bonds come from companies with lower credit ratings. Because these companies have a higher chance of financial trouble, they offer higher interest rates to attract investors.

In simple terms, when you buy a junk bond, you’re lending money to a company that may be riskier than others. In return, you get regular interest payments and your principal back at maturity. The catch? Since these companies have weaker credit profiles, the risk of missed payments or default is higher.

Understanding the Rating of Junk Bonds

Credit rating agencies decide which bonds are classified as junk bonds by looking closely at the financial health of the company issuing them. These agencies check how likely the company is to pay back its debt on time. In India, agencies like CRISIL, ICRA, and CARE use similar rating systems to help investors understand the risk involved.

The ratings range from AAA, which means excellent credit quality, down to D, which means the company has defaulted on payments. Bonds rated below BBB are considered junk bonds or non-investment-grade bonds because they carry a higher risk of not being paid back.

Here’s a breakdown of the ratings:

  • AAA: Excellent
  • AA: Very good
  • A: Good
  • BBB: Adequate (lowest safe rating)
  • BB: Some risk, but less likely to default
  • B: Higher risk of missing payments
  • CCC: Currently vulnerable to missing payments
  • C: Very high risk of default
  • D: In default

These ratings affect the interest rates bonds offer. Lower-rated bonds, like junk bonds, pay higher interest to attract investors willing to take on more risk. So, while junk bonds can offer better returns, they also come with a greater chance of the company not meeting its payment obligations.

Benefits of Junk Bonds

Although junk bonds carry a higher risk than regular bonds, they are beneficial to both investors and issuers. Here are some of their potential benefits:

For Issuers: 

  • Diverse Source of Funding: Junk bonds are additional funding sources for companies that do not qualify for traditional bonds or bank loans.
  • Flexibility: Companies use junk bond funds to finance their growth and expansion or refinance their debt.

For Investors: 

  • Potential for Price Appreciation: If the financial condition of the issuing company improves, the price of junk bonds may appreciate significantly.
  • Higher Yields: These bonds pay higher interest rates than investment-grade bonds, increasing their benefits to income-focused investors.
  • Priority During Liquidation: If the company goes bankrupt, junk bond investors get paid before the shareholders. This means investors have a better chance of getting back at least some of their money if the company can’t pay all its debts.
  • Upside Opportunity: Since these bonds have a long-term maturity date, they have enough time to perform. The issuing company’s credit rating may also improve before maturity.

Risks Associated with Junk Bonds 

Junk bonds also have some risks worth considering: 

  • Price Volatility: These bonds face significant price changes due to the uncertain performance of the issuer's finances. 
  • High Default Risk: There is a high default risk compared to investment-grade bonds with higher ratings.
  • Risk of Losing the Investment Amount: If the issuing company defaults, bondholders may lose their investment amount. 
  • Low Liquidity: Lower trading volumes often result in less liquidity.
  • Market Sensitivity: Junk bonds lose their benefits when the interest rates of investment-grade bonds increase. 

Factors Impacting Junk Bonds

Several factors influence how junk bonds perform:

  • Economic Conditions: When the economy is strong, companies are less likely to default, making junk bonds safer. In downturns, risks rise.
  • Company’s Financial Health: Improvements or setbacks in the issuer’s finances directly affect bond prices and risk.
  • Investor Sentiment: When investors are cautious, demand for junk bonds falls, lowering prices. When they are confident, junk bonds become more popular.
  • Interest Rates: Rising rates generally make fixed-income securities less attractive; falling rates boost their appeal.
  • Industry Trends: Challenges in specific sectors can affect bonds issued by companies in those industries.

Should Investors Buy Junk Bonds? 

If you’re looking to boost your portfolio’s returns and are comfortable with some risk, junk bonds can be a good option. They offer fixed interest payments and are less volatile than stocks in many ways. Plus, bondholders have priority over shareholders if the company fails.

However, because junk bonds carry higher risk than investment-grade bonds, they’re best suited for investors with a higher risk tolerance and a longer investment horizon. Since junk bonds often have maturities of 4 to 10 years and may be non-callable for 3 to 5 years, you should be ready to hold them for the long term or accept price fluctuations if you sell early.

How to Invest in Junk Bonds

Investing in junk bonds requires careful research and understanding of the issuer’s creditworthiness. Bondbazaar simplifies this process by offering access to thousands of bonds, including junk bonds, all in one place.

We are an SEBI-regulated platform where you can buy and sell bonds easily. We offer real-time trading, zero account opening or brokerage charges, and securely hold your bonds in your demat account. Interest and principal payments are credited directly to your bank account, making investing straightforward and transparent.

Conclusion

Junk bonds provide an opportunity to earn higher returns than safer bonds, but with increased risk. Understanding the junk bond meaning, benefits, and risks is key to making smart investment decisions. For investors willing to accept more risk for better income and growth potential, junk bonds can be a valuable part of a diversified portfolio.  

With Bondbazaar, you can explore a wide range of junk bonds and other fixed-income options, helping you find investments that fit your financial goals and risk appetite.

Start exploring junk bonds today and balance risk and reward wisely to build a stronger, more diversified portfolio.

Frequently Asked Questions

What are junk bonds and why are they called that?

They are high-yield bonds issued by companies with low credit ratings. The term "junk" reflects the higher risk of default.

Are junk bonds legal and regulated in India?

Yes, junk bonds are SEBI-regulated and rated by agencies like CRISIL, ICRA, and CARE.

Can I invest in junk bonds online through Bondbazaar?

Absolutely. Bondbazaar offers easy, transparent access to junk bonds and other fixed-income securities.

How risky are junk bonds compared to traditional bonds?

They carry higher default and price risks but also offer higher returns.