JUNK BONDS

Junk bonds are bonds issued at higher yields than investment grade bonds. The higher the yield, expressed as a percentage rate, the higher the risk of the bond. Two major rating services, Standard and Poor's, and Moody, have slightly different bond rating scales. Bonds rated lower than BBB on Standard and Poor's, or Baa on Moody are considered junk bonds. In comparison, Standard and Poor's rates investment grade bonds at BBB up to AAA.

Junk bonds, issued by companies without long track records of sales and earnings and/or with shaky credit ratings, must pay higher yields to off-set the real risk of nonpayment. They attract risk-oriented investors willing to gamble that companies issuing the higher interest rate bonds will be able to meet the terms of the bonds. The junk bond market is volatile and investment institutions with fiduciary responsibility, charged with investing wisely for a beneficiary's benefit, generally avoid junk bonds.

Racing into the U.S. investment scene in the 1980s, junk bonds allowed companies to raise funds cheaply. Legendary junk bond guru Michael Milken of the investment company Drexel Burnham Lambert had dazzling success raising enormous sums of capital for companies through the sale of high-yield junk bonds. Milken and Drexel were behind many junk bond finance attempts at company takeovers. In 1988, interestingly, the fortunes of many unsuspecting buyers were lost when the Securities and Exchange Commission charged Milken and Drexel with insider trading and stock fraud, which drove the company out of business.

In the late 1990s junk bonds underwent a reincarnation of sorts; they became a more acceptable part of a highly diversified investment portfolio. A number of professionally managed high yield junk bond funds emerged and offered investors a safer route than buying individual issues.