The high yield bond market, also referred to as the junk bond market, speculative grade bond market, or non-investment grade bond market, deals with the trading of high yield bonds.
A high yield bond is a type of a bond which has a below investment grade rating at the time of its being purchased. These bonds are characterized by a higher default risk and other types of financial risks. Because of the involvement of higher risk, these bonds offer a higher rate of yield or return to the investors. The idea here is that investors will be drawn the prospect of a higher return on their investment. One of the most important features of high yield bonds is the presence of incurrence covenants and the absence of maintenance covenants. The high yield bond market is completely different from the majority of bank loan markets and investment grade bond markets, in that these bonds usually have a lower credit rating than investment grade bonds.
Normally, two types of risk are involved in the high yield bond market:
- Interest rate risk
- Credit risk
The credit risk of a high yield bond is assessed by a credit rating agency which assigns a credit rating for that bond. For example, a highly-rated bond may receive a AAA rating. The important credit rating agencies for high yield bonds are the following:
- A.M. Best
- Fitch Ratings
- Moody's
- Standard and Poor's
- Dominion Bond Rating Service (DBRS)
The different types of bonds that are traded in the high yield bond market include the following:
- Convertible bonds
- Zero-coupon bonds ("Zeros")
- Split-coupon bonds
- Multi-tranche bonds
- Deferred-interest bonds
- Extendable reset notes
- Floating-rate and increasing-rate notes
- Pay-in-kind bonds
- Straight cash bonds
Sometimes, the high yield bonds are categorized into the following types:
- Rising stars: The rating of this type of high yield bonds continues to increase simultaneously with the improvement of the credit quality of the bond issuer.
- Fallen angels: A large number of bonds, which had been performing quite well, become high yield bonds because of the decline of the credit quality of the bond issuer as a result of variable and adverse business situations.
Various indices used in the high yield bond market include the following:
- The Merrill Lynch High Yield Master II
- The CSFB High Yield II Index or CSHY
- Bear Stearns High Yield Index or BSIX
- The Merrill Lynch BB/B Index
