Junk Bond
A junk bond, formally referred to as a high-yield bond or speculative-grade bond, is a corporate debt security rated below investment-grade by major credit rating agencies — below BBB- by S&P Global Ratings or below Baa3 by Moody's — reflecting a higher probability of default and compensating investors with elevated interest rates.
The term junk bond entered popular usage in the 1980s, largely through the high-yield bond market developed by Drexel Burnham Lambert and its financier Michael Milken, who pioneered the use of speculative-grade bonds to finance leveraged buyouts, hostile takeovers, and expansions of companies too small or financially weak to issue investment-grade debt. The market has since grown into a multi-trillion dollar segment of the U.S. capital markets, with junk bonds playing a central role in corporate finance for a broad range of industries.
High-yield bonds carry elevated default risk relative to investment-grade bonds, but default rates vary significantly across credit cycles. During economic expansions, U.S. high-yield default rates have historically been low — often below 2% annually. During recessions or sector-specific downturns, default rates can spike sharply, reaching double digits during severe stress events. The compensation for this risk, measured by the high-yield spread (the average yield differential between high-yield bonds and comparable-maturity Treasuries), has historically ranged from under 300 basis points during benign market conditions to over 1,000 basis points during financial crises.
The high-yield bond market occupies a different segment of the capital structure than leveraged loans, though both serve speculative-grade borrowers. High-yield bonds are typically unsecured or secured on a second-lien basis, ranking junior to term loans in a company's debt structure. They generally carry fixed coupon rates, in contrast to the floating-rate structure of leveraged loans and CLO-eligible credit. This difference makes high-yield bonds sensitive to interest rate movements in a way that leveraged loans are not.
Issuers in the U.S. high-yield market span a wide range of industries, with energy, health care, telecommunications, and consumer goods among the historically largest sectors. Private equity-backed companies that have undergone leveraged buyouts represent a significant portion of high-yield issuance, as the debt used to finance buyouts is typically in the form of high-yield bonds and leveraged loans.
Credit covenants in high-yield indentures define the contractual boundaries within which the issuer must operate, including restrictions on additional indebtedness, asset sales, dividend payments, and mergers. These protections are more limited in the modern high-yield market than they were historically, as the prevalence of covenant-lite structures has grown alongside the expansion of institutional investor demand for high-yield exposure.