Junk bonds are securities that pay high interest because they are issued by companies with little collateral, as tends to be the case with new businesses. A bond is an IOU which promises to pay a fixed amount on a fixed date, with (usually) interest payments in between. Junk bonds are bonds that yield high returns on the loan with higher risks. Government and blue chip companies issue bonds but the risk is lower because the chance of default is less. Junk bonds are issued by companies which are not monitored for their credit ratings. The term junk bonds originally applied to sound companies too small to merit a credit rating. The risk was not much greater than normal bonds because the companies assets were generally greater than the value of the bonds issued. Junk bonds are now being issued for more than the company is worth. The risk is worth taking if cash flow in the company allows interest to be paid and the assets of the company are rising. When this is not the case the bonds become worthless. Such bonds may also be used to acquire other businesses under hostile and controversial circumstances. Otherwise health companies may then face ruin because they are unable to manage the debt resulting from such takeover operations.
Junk bond is a bad term for a good investment opportunity. When investors recognize the risk and are willing to take it, the investment opportunity is like any other with greater risks for greater rewards. Such bonds provide an important source of finance where banks are reluctant to provide it. Only 5% of American companies have high credit ratings. Cutting off junk bonds, removes a vital credit opportunity for the remaining 95%, usually including those run by minority groups and women.