Garbage Collectors

Taking In The Trash

High-yield securities are bonds that offer historically high yields. They come in several flavors, including preferred stock, foreign government, municipal and corporate bonds. High-yield, or junk, securities are those considered to be below investment-grade quality, earning a credit rating below triple B, the lowest standard of investment-grade securities. A lower credit rating means an increased chance that the issuer may not be able to make interest and principal payments as promised. Because of the possibility that these securities may default, costing investors both interest payments and principal, the yields proffered are higher than investment-grade bonds of similar maturities.

There are two types of junk bonds: First are bonds that were issued initially as investment-grade but through their underlying firm's financial difficulties lost this high credit rating. These are called "fallen angels." The second and more common type of junk bond is a bond issued by a company that itself is of lower than investment-grade credit quality.

Robust earnings can change either type of security from junk to higher quality, resulting in potential profits for the investor. Similarly, in either situation the fate of the issuer could take an unexpected turn for the worse, leading the bond into default and the bond's owner into losses.

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This article was originally published in the August 1997 print edition of Entrepreneur with the headline: Garbage Collectors.

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