What is High-Yield Bond Trading?

Jim B.

High-yield bond trading refers to the buying and selling of bonds that generally return higher interest payments to investors than investment-grade corporate bonds. The higher interest rates are issued to make up for the fact that these bonds are saddled by credit agencies with low credit ratings. A low credit rating means that the corporation issuing the bond is considered extremely risky and could default on the bond. Investors partake in high-yield bond trading to take advantage of the high interest payments and can mitigate the risk by including the bonds in mutual finds.

Businessman with a briefcase
Businessman with a briefcase

Corporations that are seeking capital to grow their business or to survive hard times can get this capital by issuing bonds to investors. When an investor buys a bond, he is essentially lending money to the corporation with the expectation that the principal of the loan will be repaid along with interest. If the corporation issuing the bond is on shaky financial footing, it may be forced to lure investors with bigger interest payments. Such bonds are the basis of high-yield bond trading.

Several major credit companies determine which bonds are risky and thus must be bought and sold via high-yield bond trading. The bonds issued by such a corporation may have ratings that denote that the corporation is in danger of defaulting or may already be in default. Any investors deciding to pursue such bonds will realize from the credit rating that there is the chance that their initial investment may not be returned to them.

The compensation for those investors who deal in high-yield bond trading comes in the form of the higher interest rates these bonds give out, which is where the term high-yield comes from. These bonds are yielding more than investment-grade corporate bonds, meaning that investors who choose corporations that manage to live up to the bond agreement can make significant profits on their investments. High-yield bonds are a great example of an investment opportunity with great risk and potentially great reward.

To lessen the risk involved in high-yield bond trading, many investors include them in their investments in mutual funds. Mutual funds collect funds from different investors, funds that are then invested in multiple trading vehicles across the market. If a fund contained several high-yield bonds, then one or even a few of those bonds could default and the investor's overall capital could still conceivably be protected. Using mutual funds allows investors the benefits of high-yield bond funds while removing some of the disadvantages.

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