Credit rating agencies sort bonds by default risk. Bonds below investment grade pay higher coupons because investors demand more yield for the extra chance of non-payment. That extra income is compensation, not free money. In stress periods, junk bonds can fall hard as refinancing becomes difficult. They can still have a place in diversified portfolios for sophisticated investors who understand credit risk.

Key takeaways

  • Higher yield reflects higher default and price risk.
  • Ratings can change; a bond can become junk after a downgrade.
  • Liquidity often worsens when markets panic.
  • Read the issuer’s leverage and cash flow, not just the coupon.