Those junk bonds (high-yield bonds) always have a greater risk of default because such is their nature. The cheaper this bond is the higher profit it may make for you if you sell it in time. These papers are issued by companies to attract money for development. It means that if something negative happens those companies won’t be able to pay you back as they haven’t earned anything yet.
For example, you want to start a new company to make, say, clothes. You go to your bank and take a loan, your bank issues a junk bond for that (that’s too simplistically of course). You hire some people, rent an office, give advertising, etc. But in a month or so the textile prices rise and at the same time customers suddenly start to buy less clothes than before. If you are a big company chances are you won’t even notice that much. But if you are a small, weak, new company you may find yourself out of money to continue operational existence.
From time to time, this and that bond defaults, but it may become a negative tendency like in 90s, 2000 or 2007. And the whole market of the junk bonds collapses and this is a signal of the coming economic crisis.
Important is the fact that the becoming of such a “global” default is inevitable.
What can you do if you read papers and they say that junk bonds are going to collapse in the near future?
- Don’t buy junk bonds 🙂
- Prepare yourself for another crisis.
Do bubbles cause crisis? – our next article is all about it.