The banking industry has set basic standards and categories for measuring risk. What is the definition of a junk bond?
“Investment Grade Versus Junk Grade Bonds”
Credit rating agencies – such as Moody’s and Standard & Poor’s – will conduct an objective assessment of a corporations’ likelihood of repaying its debt to assign it a credit rating. There are many levels to this scale including the difference between investment-grade and non-investment grade. For Moody’s, anything under “Ba” is non-investment grade; for Standard & Poor’s, anything under “BB” is non-investment grade.
The word – “junk” – actually refers to a corporate bond being “non-investment grade.” The junk bond can serve as a warning that something in the company’s balance sheet does not satisfy common credit industry accounting norms. The “junk bond” is considered to be a high-risk, high-reward investment vehicle according to Marc Sparks.
For some investors, this “high-yield” non-investment grade brand is an attractive opportunity to increase profits. Some of these junk bonds might be repackaged into Collateralized Debt Obligations (CDOs) or Collateralized Loan Obligations (CLOs).