Junk Bonds: Meaning, Types, Risks & Ratings in India

Say your bank FD pays 7%, and someone shows you a bond paying 12%. Sounds tempting? So many people’s first thought is, “Why isn’t everyone buying this?” The answer is that the bond is probably a junk bond, and that extra 5% is the price of a risk you may not have fully looked at yet.

This blog covers what junk bonds are, how they work, how Indian rating agencies classify them, and who can reasonably hold them.

What are Junk Bonds?

A Junk bond is issued by a company whose credit rating is weak. A low rating means the agency sees a real chance that the company may struggle to pay interest or return your principal on time. You’ll hear Indian bankers and advisers say high-yield bonds or below investment grade bonds more often than “junk”, but it’s the same thing.

The logic is easy to follow. If a friend with a steady salary asks to borrow money, you would lend it at a decent rate. If a friend whose business has uneven cash flow asks, you will definitely want more interest, because you are less sure of getting it back. Junk bond issuers are that second friend. They pay more because nobody would lend to them otherwise.

How Do Junk Bonds Work?

A company raises money from investors, pays a fixed coupon every year or every few months, and returns the face value when the bond matures.

What changes is how much can go wrong in between. The company might delay a payment. It might default altogether. Or its rating might get cut again, and the bond price falls even though no default has happened yet. If you need to sell at that point, you will take the loss.

The Liquidity Problem

Liquidity is the other problem people do not consider. A lot of lower-rated bonds hardly trade on the exchanges. You may want to sell but do not find anybody on the other side, or only at a price that is not a good fit for you.

Junk Bonds in India 

1. IL&FS

Start with IL&FS. Until mid-2018, it was a name that debt investors trusted, with top ratings to match. Then payments started getting delayed. 

Within weeks, the ratings were cut sharply, and the damage did not stay with one company. Lenders, NBFCs, and debt funds holding its paper were all impacted, and the whole credit market turned cautious almost overnight. 

2. Franklin Templeton

Franklin Templeton’s story came two years later, in April 2020. The fund house closed six debt schemes, holding roughly ₹25,000 crore between them. These schemes had leaned on lower-rated bonds to squeeze out extra returns. COVID happened, investors rushed to redeem, and those bonds simply couldn’t be sold fast enough at a reasonable price. So the schemes stopped taking redemptions.

Most investors did get their money back, and in many cases more than the value at the time of closure. But it took years.

Read Also: How to Buy and Sell Bonds in India?

Different Credit Ratings of Junk Bonds

In India, ratings come from agencies like CRISIL, ICRA, CARE Ratings, and India Ratings. The scale runs from AAA at the top down to D, which means the issuer has already defaulted.

The cut-off sits at BBB-. Anything at BBB- or above is called investment grade. Anything from BB+ downwards is junk territory.

A BB-rated bond is speculative, so the issuer can probably pay today but carries a chance of trouble. 

At B, repayment depends heavily on the business performing well. 

C means default is a high possibility, and D means it has already happened. 

You will also see + and – signs, and a BB+ is clearly in better shape than a BB-.

Another thing about ratings is that they are not fixed for life. Agencies review issuers regularly, and a bond that looked decent when you bought it can get downgraded a year later. 

Credit Rating	Category	Meaning
AAA	Highest Safety	Lowest credit risk; strongest repayment capacity.
AA to A	High Safety	Strong repayment capacity with relatively low credit risk.
BBB to BBB-	Investment Grade	Adequate repayment capacity but vulnerable to adverse conditions.
BB+ to BB-	Speculative Grade	Higher credit risk; repayment may be affected by business conditions.
B	Highly Speculative	Repayment depends heavily on favourable business conditions.
C	Very High Risk	Default is highly likely.
D	Default	The issuer has already defaulted on its debt obligations.

Types of Junk Bonds

1. Fallen Angels

These bonds are issued by companies that used to be high-quality and financially stable. Due to market downturns, poor management, or rising debt, they were downgraded to the junk category. 

2. Rising Stars

These bonds are issued by young, fast-growing companies or startups that are still in their nascent stage. Their credit ratings start low, but they carry the potential to scale up as their business scales up. 

3. Distressed Bonds

These are bonds with no rating and are issued by a company already in trouble. Most retail investors should stay away from these completely.

Did you know? 

If you do not want to pick individual bonds, Credit risk mutual funds invest a large chunk in lower-rated papers on your behalf. It’s an easier route.

Features of Junk Bonds

• High Yield: Coupons of junk bonds are often in double digits, well above government securities or AAA corporate bonds. If you invest ₹1 lakh in a 7% FD, you earn ₹7,000 a year. The same money in a 12% bond earns ₹12,000, but only if the company actually pays.
• High Returns: Higher returns come with higher default risk, and the bond’s price can also swing a lot on company news, sector troubles, or interest rate movements. Exits are difficult when compared with listed shares, since trading volumes are lower.
• Secured/Unsecured: Some junk bonds are backed by collateral such as property or receivables, while others are unsecured. If things go wrong, a secured bond gives you a better chance of recovering at least part of your money.

Who Should Invest in Junk Bonds? 

Not everybody, and certainly not investors who are first-time bond buyers. If you have never invested in bonds, start with government securities or AAA-rated papers and get comfortable first.

Junk bonds can be a fit if you already have a strong base of safer investments and want an allocation for higher returns. You should be able to lose that money without it changing your life. You should also be able to read a rating report and understand a company’s financials, and have enough time to wait through a bad patch.

They are a poor fit for retirees who depend on regular income, or for money meant for something near-term like school fees or a house down payment. Don’t buy one just because the yield number looks nice on the screen.

Most advisers suggest keeping this exposure to a small portion of your overall debt allocation and spreading it across several issuers, rather than one. Before buying, read the rating report, check the company’s cash flows, and find out whether the bond is secured.

Read Also: Benefits of Investing in Bonds

Conclusion 

Junk bonds can pay you far more than an FD ever will. They can also leave you with delayed payments or a partial loss. If you want to try them, start small, stick to issuers you understand, and treat a very high coupon as a warning sign instead of a bonus. It is suggested that staying with safer bonds is a perfectly good decision. Not every portfolio needs this kind of risk.

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