High Yield Corporate Bonds

You are bound to have heard mention of high yield corporate bonds. Your investor friends are sure to have related stories about fortunes earned on the backs of them during the financial boom times. But what exactly are these high yield bonds and why isn't everybody investing in them?

All bonds are debt securities issued by organisations to raise capitals for a variety of purposes. When you buy a bond, you are essentially lending your money to the company/government/body that issues it. In return for your money, they issuer agrees to pay you interest and ultimately to return the principal - the money loaned - when the bond matures, at a date in the future that you both agree on.

Although all bonds work along this principle, not all bonds are the same. Bonds are rated by credit rating agencies. The main ones are Moody's Investors Service, Standard and Poor's Ratings Services and Fitch Ratings. They rate bonds on a scale from A to D, AAA being the safest and D the riskiest.

Investment grade bonds are those that score a BBB or higher on this scale. They are considered to be reliable. High-yield bonds do not qualify for this rating, which means that they have a greater risk of default. They may not pay interest or the principal in a timely manner.

Such a rating makes investors wary and as a result the companies must do their utmost to entice them. What they do is they pay a higher interest rate to attract investors and to compensate them for the risks involved in investing in organisations of lower credit quality.

In short, high yield corporate bonds constitute a gamble. The bonds have been deemed to be risky by the financial experts but there is substantial money to be gained from investing in them. If you bet on high yield financial bonds and gain, you stand to gain quite a lot. However, if you lose, you can end up losing everything.

The clue is in the name. There is potential for high yield but there is also a potential for risk and loss. The choice is yours to make but you can't say that you haven't been warned.