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High-yield bonds are issued by entities that have inadequate cash flows. Such companies find it difficult to make regular interest payments and repay the principal amounts on maturity. Hence, such bonds are suitable for those who have high-risk appetites. Furthermore, the issuer attaches a high bond rate to such bonds to reimburse the investors for the high risk they take, which is why high yield bonds India continue to attract investors seeking better returns.
Read further to weigh the pros and cons of investing in high-yield bonds and make appropriate investment decisions.
The Pros of Investing in High-Yield Bonds
The following are the beneficial aspects of high-yield bonds, making them an attractive investment option:
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Higher Payouts
In simple terms, as the companies issuing high-yield bonds do not have an investment-grade rating, they have to attract investors with bonds with a high coupon rate. It allows the investors to earn better returns compared to other traditional bonds. Thus, if such bonds pay well, the returns are sure to be higher than those of investment-grade bonds.
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Capital Appreciation
When companies issue high-yield bonds owing to their low credit rating, it is mostly associated with negative cash flows. However, it is not necessary that the company will continue to face such inadequacies in cash flows. If there are clear signs of improvement, the prices of the said bonds will definitely rise, leading to potential capital appreciation and overall profitability.
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Priority
The bondholders of high-yield bonds take a huge risk when investing. Hence, it is important to note that if the company becomes bankrupt or there is a scenario of liquidation, the bondholders of high-yield bonds get priority in terms of repayments and settlements. They will be paid before the stockholders.
The Cons of Investing in High-Yield Bonds
As there are certain benefits, there are also some disadvantages of investing in high-yield bonds. Discover them below for making a calculated decision:
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Default Risks
Already, high-yield bonds are issued by companies with low credit ratings. Thus, if the cash flow of such companies does not improve and they fail to make repayments to bondholders, it is a great default risk. Hence, investors carry a huge risk when high-yield bonds are included in their portfolios.
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Liquidity Issue
Good liquidity is when an investor is easily able to buy and sell a security in the market. However, when it comes to high-yield bonds, investors are reluctant to purchase them. Reason? The high default risk associated with them. Hence, it becomes difficult for investors to sell such bonds, adversely impacting liquidity.
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High Risks During Recession
During the recession, some bonds go up in value to attract relevant investors during such times. However, companies who have already issued high-yield bonds lose the opportunity to do so as they have already issued bonds with a high coupon rate. Thus, other bonds become more attractive to investors. It may make high-yield bonds worthless, leading to losses for investors.
Wrapping Up!
If the companies issuing high-yield bonds improve their cash flows and financial performance, it can really benefit the investors of such bonds. However, the risk of high defaults and economic recession cannot be ignored. Thus, it will be wise for the potential bondholders to research the companies well before making any investment decisions.
Get to know more about the high-yield bonds with GoldenPi and make a smart investment decision.
FAQs About What are High-Yield Bonds?
1. What are the two subcategories of high-yield bonds?
The two subcategories of high-yield bonds are fallen angels and rising stars. The fallen angels are bonds that are demoted by a major credit rating agency owing to the company’s poor credit quality. Meanwhile, rising stars are bonds that have reflected improvement in their credit quality and are moving towards investment quality.
2. What is the difference between high-yield bonds and investment-grade bonds?
High-yield bonds are issued by entities with a low credit rating. Thus, they carry a huge default risk but a higher coupon rate. Meanwhile, investment-grade bonds are issued by companies with a strong credit rating. Thus, they do not carry a huge default risk like high-yield bonds and thus offer lower returns compared to them.
3. How to invest in high-yield bonds?
Interested investors can invest in high-yield bonds through broker-dealers. One can also invest in these bonds indirectly through mutual funds or exchange-traded funds that focus on high yields.
