Junk Bond Investments in Rising Inflation
There’s a high chance that interviewers for #salesandtrading #privatebanking and #assetmanagement divisions will ask you to discuss the impact of basis point hikes on the market. High yield investment bonds (or junk bonds) are touted as one such strategy to offer better resilience in an inflation-riddled market.
Here's what you need to know to about junk bonds:
✅ To tame the sky-high inflation in the US, the Federal Reserve has been spiking interest rates since June, and investors expect the situation is 'far from done yet' as Mary Daly, San Francisco Fed President, said. Junk bonds as a financial product in tune with the broad market are something you need to know.
✅Unlike other bonds (investment-grade bonds or Treasury bonds issued by countries), junk bond issuers have a lower credit rating. Presumably, low-grade bond issuers risk filing insolvency more than others. Therefore, higher yields can attract investors to the high-risk junk bond market.
In particular, junk bonds are rated as BBB- by rating agencies like Standard & Poor's or Fitch, or Ba by Moody's.
✅ Prominent companies such as Ford, Netflix, and Tesla will also issue junk bonds due to their business nature of having negative growth rates and weak cash flow (investment expenditure outweighing income).
✅ These bonds have a higher risk of default, yet are associated with high potential rewards. However, junk bonds still retain a comparatively lower risk than stocks because bondholders have a higher succession in getting back money than stockholders when liquidating the company.
The US investment management firm PIMCO (Pacific Investment Management Co.) has the Global High Yield Bond Fund, which invests two-thirds of its assets in high-quality global high yield bonds. Until 12 July 2021, the Fund yielded 4.88%, while that for the Global Investment Grade Credit Fund was 2.57%, indicating a two-third return discrepancy.
✅ High-Yield Bond Spread, or credit spread, is a noteworthy numeral showing the percentage yield differences of junk bonds compared to investment-grade bonds. In mid-June, spreads on US junk-rated corporate bonds exceeded 500 basis points (i.e., junk bonds have a 5% higher yield than others, such as the US Treasury Bonds). The upsurge in the yields of junk bonds, perceiving that investing in low-grade bonds is riskier, causing firms to provide a higher interest as a temptation. A higher spread can be an indication of the slowing growth of the market.
✅ While Investors are worried about a weakened economy or even a recession signal, junk bonds can offer a better risk/reward alternative in the backdrop of low but rising yields and stressed equity valuations
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