High-Yield Bond
A high-yield bond — also called a junk bond — is a corporate bond rated below investment grade (below Baa3/BBB- by Moody's and S&P respectively), offering higher interest rates to compensate investors for the elevated risk of default.
High-yield bonds were long dismissed as unsuitable for serious investors until Michael Milken and Drexel Burnham Lambert demonstrated in the 1980s that a diversified portfolio of junk bonds could offer superior risk-adjusted returns. Milken's research showed that the yields on high-yield bonds more than compensated for actual default rates, creating a compelling investment case. While Milken's career ended in controversy, he fundamentally changed how Wall Street thought about credit risk and opened the high-yield market to mainstream issuers.
Today the U.S. high-yield bond market exceeds $1.5 trillion and is a critical funding source for leveraged buyouts, private equity-backed companies, and growing businesses that have not yet achieved investment-grade credit quality. Companies like Ford, Netflix, and Spirit Airlines have all been high-yield issuers at various points in their history. The market includes 'fallen angels' — formerly investment-grade bonds that were downgraded — as well as 'original issue high-yield' bonds issued below investment grade from the start.
The defining characteristic of high-yield bonds is their credit spread — the yield premium over comparable Treasury bonds. During periods of economic expansion and low default rates, high-yield spreads compress as investors become more willing to take on credit risk. During recessions or financial crises, spreads widen dramatically: in early 2020 at the height of the COVID-19 market panic, high-yield spreads briefly exceeded 1,000 basis points (10 percentage points) over Treasuries before the Federal Reserve's intervention stabilized markets.
Default rates are the central risk in high-yield investing. Historically, annual default rates on U.S. high-yield bonds have averaged around 3–4%, but have spiked to 10–15% during severe downturns like the 2001–2002 tech bust and the 2008–2009 financial crisis. Recovery rates — the percentage of face value bondholders receive after a default — average around 40 cents on the dollar for senior unsecured bonds, but vary widely based on the issuer's assets and capital structure.
High-yield bonds behave like a hybrid between investment-grade bonds and equities. They have shorter effective duration than investment-grade bonds (because high coupon rates and shorter maturities are common), and their prices are driven more by credit fundamentals than by interest rate movements. The ICE BofA U.S. High Yield Index is the most widely followed benchmark, tracking over 1,800 bonds and serving as the reference for the SPDR Bloomberg High Yield Bond ETF (JNK) and the iShares iBoxx High Yield Corporate Bond ETF (HYG).