Junk Bond

Full form: High-Yield Bond

Investments

Junk bonds are debt instruments rated below investment grade (BB or lower) that offer high yields to compensate for high default risk. In India they are rare in retail markets -- corporate FDs of struggling companies and some high-yield NCDs fall in this category.

In detail

Rating below BBB = below investment grade = junk or speculative grade.nnYield premium over AAA: 4-10%+ depending on credit quality.nnIndia context: DHFL NCDs (before collapse), IL&FS paper, some cooperative bank FDs -- all fell into junk territory as problems emerged. Retail investors who chased the extra 1-2% yield lost principal.nnRule: for retail investors, never invest in corporate instruments below AA rating. The extra yield does not compensate for the risk of principal loss.

Formula

Junk bond yield = Risk-free rate + Credit spreadnTypical junk spread: 400-800 basis points above government bond yield

Real-life example

🇮🇳 India example

A cooperative bank offers FD at 10% vs SBI at 7%. That extra 3% is compensation for higher default risk. If the bank faces financial trouble (several cooperative banks have failed), you could lose principal. DICGC insurance covers only Rs 5L. For amounts above Rs 5L: the extra 3% does not justify the risk.

Frequently asked questions

Are company FDs safe compared to bank FDs? ▼

Company FDs are NOT covered by DICGC insurance (unlike bank FDs up to Rs 5L). Even AA-rated company FDs carry more risk than equivalent-rate bank FDs. For equivalent or lower returns: always prefer bank FDs for safety. Only consider company FDs from AAA-rated entities (HDFC Ltd historically) for a small portion of portfolio.