Broker Junk Bonds

Broker Junk Bonds

If you ever bought something cheap that turned out to be junk, I bet you were sorely disappointed in the quality. That great deal on scrap roofing material may have landed you, literally, in the doghouse, or the reason behind that excellent price on a used car may have become apparent when you broke down on the freeway.

Whatever the case, when you find an unbelievable deal on anything, it is often too good to be true. Broker junk bonds are no exception. Let's take a look at this trick in the bond world.

What is a Junk Bond?

Junk bonds are bonds worth very little that offer inflated return rates. The price for these bonds is usually very low (to match the worth), but junk bonds are almost always risky investments.

Even though the stated and historical return on these bonds is high, there is a reason for the company's willingness to pay such high returns to investors: junk bond companies have very poor credit, and the only place they can find a backing is through investors willing to gamble the risks of backing a fledgling company for the potential of large returns.

What About Good Companies in Bad Credit Situations?

There are arguments in the junk bond trade that good companies can find themselves strapped for cash. They could experience a credit crash for any number of reasons, be placed in the junk bond realm, and be able to dig themselves out of the credit hole.

This could be the case of a small minority of companies, but the majority of junk bonds are purely...junk. Most of the companies that find themselves in the very poor credit pool have a small chance of swimming to safety, and you are safer investing in proven companies than in good companies gone bad.

My Broker Believes in this Company

Even if your broker tells you not to miss out on Company A's junk bond opportunity, you should beware. Your broker may be a wonderful person. Your broker may even have insider information that a rainbow is going to chase away Company A's storm clouds, but if you are not ready to sing Company A's praises, you should pass on this “opportunity.” Bottom line: if you do not believe in the company, don't buy the bond.

There may be treasures among the trash, but if the junk statistically outweighs the diamonds, you may be better off backing a tried-and-true company that you believe in. In any case, when you consider investing in a junk bond, carefully decide if the company is on the path to success or on the way to the junkyard before staking a claim.

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MoneyCone's picture

MoneyCone wrote:

Mon, 04/18/2011 - 12:35 Comment #: 1

My 401K advisor was actually suggesting low-quality Junk bonds! I shook my head and walked away!

Christa Palm's picture

Christa Palm wrote:

Thu, 04/21/2011 - 00:03 Comment #: 2

MoneyCone, wow! Unbelievable! Glad you walked away -- those bonds can be major trouble -- unless you have some serious insider information (very rare to have this info, though, huh?).

Financial Definitions - Glossary for Understanding Finances 's picture

Financial Definitions - Glossary for Understanding Finances wrote:

Thu, 01/19/2012 - 21:46 Comment #: 3

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