Junk Bonds Explained: High Risk, High Yield Investing

Junk bonds in India are speculative-grade or high-yield corporate debt instruments. They are rated below investment-grade (BB+ or lower) by top agencies like CRISIL, CARE or ICRA. Returns may seem attractive, but bond issuers (companies) may default if they face bankruptcy or financial issues. 

Companies with lower credit ratings mostly issue these debt securities, which carry considerably higher risk. To compensate, they generally offer higher yields than comparable investment-grade debt. Let us learn more about junk bonds, how they work, their benefits, risks, ratings and other vital aspects below. 

Key Takeaways

• Junk bonds are also known as speculative or non-investment-grade bonds. They are corporate debt securities issued by companies with lower credit ratings (BB+ or lower). 
• Because these companies face a higher risk of defaulting on principal or interest payments, these bonds offer higher yields to compensate for that risk. 
• These instruments, while offering higher yields, have considerable default risks and liquidity limits; i.e. selling them is hard during market downturns. 

What Are Junk Bonds?

Junk bonds are corporate debt securities with credit ratings below investment grade (BB+ or less), as rated by Indian rating agencies such as ICRA, CRISIL, or CARE, and are issued by companies with lower credit ratings. They are also known as speculative or non-investment grade bonds. The key factor is that issuing companies have a higher risk of defaulting on principal or interest payments. As a result, these bonds offer significantly higher interest rates, or yields, to attract investors and compensate for the risk. Here are some key aspects worth noting about these bonds: 

• Ratings: 

Indian rating agencies classify credit safety from AAA (highest level of safety) to D (default). Anything rated BB+ or lower is classified as a junk or speculative bond. 

• Who Issues: 

Companies, startups, and other entities that are undergoing financial restructuring or have higher debt-to-equity ratios mostly issue these bonds. Established companies may also issue them during rough patches. 

• Who Invests: 

Investors in lower-rated debt include institutional investors, AIFs, high-net-worth individuals, and other investors who can and are willing to assess credit risk. 

In India, retail investors may access them through registered OBPPs (online bond platform providers). 

• Advantages: 

They have higher coupon rates than regular fixed-income products. They may help investors diversify or boost portfolio returns. 

If the issuing company’s financial health improves and credit ratings are upgraded, the bond's market value may rise, potentially generating a capital gain for an investor who sells before maturity. 

• Main Risks: 

The key risk is the company going through a cash crunch and failing to make periodic interest payments or repay the principal at maturity. 

Junk bonds can be secured or unsecured. Before making an investment, the investor should look at the security package, the ranking, the collateral, the guarantees and the terms of the issue.

Why Are They Called "Junk" Bonds?

The term originated because of the high-yield securities that carried higher default risk, making them seem like junk compared with investment-grade or safer bonds. 

The term 'junk bond' predates the modern high-yield market, but it became strongly associated with the development of the modern high-yield bond market in the United States during the 1970s and 1980s. 

Here are the key milestones in the inception of what we know as junk bonds today: 

• Original Junk (Pre-1970s): 

Junk bonds were mostly regarded as fallen angels in the market before the 1970s. These were bonds issued by companies that were once financially strong, but had fallen on hard times. 

They also saw their credit ratings downgraded to junk status. This was the original description. 

• Milken Revolution (1970s onwards): 

Michael Milken shifted this market by issuing new bonds rated below investment grade from the outset. He used these bonds to raise capital for growing companies that traditional banks ignored. 

He understood that these bonds could pay higher interest rates to offset their default risk. By building a huge liquid market for these high-yield securities, he even earned a popular moniker- the Junk Bond King. 

• Corporate Raider Period (1980s onwards): 

Drexel Burnham Lambert and Michael Milken began using junk bonds to finance hostile takeovers and LBOs (leveraged buyouts). This contributed to the use of high-yield bonds in leveraged buyouts and other corporate-finance transactions.

As a major corporate raider, Milken helped establish Milken’s legacy and this term's place in financial history. 

How Do Junk Bonds Work?

Knowing how junk bonds work is imperative for any investor considering them. They are high-yield corporate debt instruments that pay higher interest rates because they carry a higher risk of issuers failing to make payments.

In India, you can gain exposure to lower-rated corporate debt through instruments such as bonds and non-convertible debentures (NCDs), depending on the issuer and issue structure.

Here’s how they actually work: 

• Loan: As a retail investor, you lend funds to a company by purchasing its bond. In return, the company promises to pay regular interest (coupon) and return the original investment (principal) when the bond matures. 
• Risk-Return Aspects: Since the issuing company has high debt or a slightly messy balance sheet, it cannot borrow at affordable rates from banks or sell top-rated bonds. Hence, it offers a higher interest-rate premium to attract investors. 
• Credit Ratings: Credit rating agencies in India, i.e. ICRA, CRISIL or CARE assess these entities. Bonds rated BB+ or lower (down to D for default) are categorised as junk or speculative grade bonds. 
• Yield Differences: While safer Government securities or AAA corporate bonds in India may offer lower single-digit returns, lower-rated corporate debt generally offers higher yields than comparable higher-rated debt, although actual yields can vary substantially depending on the issuer, maturity, security, and market conditions.
• High-Yield or Junk Aspects: True junk or speculative bonds make up a smaller share of direct retail options in India than in the United States. Market participants and platforms may use the term 'high yield' differently. Investors should distinguish between a marketing description such as 'high yield' and the formal credit-rating category assigned by a CRA.
• Accessibility through Platforms: Indian retail investors may readily access high-yield corporate bonds or NCDs at lower ticket sizes. This is possible through SEBI (Securities and Exchange Board of India)-regulated OBPPs. 
• What You Should Do: Look at bonds secured by physical assets or specific company receivables instead of unsecured promissory notes. Because lower-rated debt carries significant credit and liquidity risk, investors should limit concentration and spread investments across issuers and sectors based on their risk tolerance and financial position. 

Junk Bond Ratings

Here is a guide to junk bond ratings that you can use. 

*Note that S&P and Fitch use + and – signs for indicating relative standing in any segment. Moody’s uses 1, 2, and 3, where 1 is the highest rank in the group. 

Junk Bond Ratings by Indian CRAs: 

Indian CRAs use a different rating system. Here is a closer look at the same: 

Junk Bonds vs. Investment-Grade Bonds

Investment-grade bonds are safer fixed-income instruments rated BBB or higher, while junk bonds (high-yield bonds) are rated BB+ or lower and offer higher interest rates to compensate for higher default risk. Let us look at the key differences between these bonds below: 

Pros & Cons: 

Investment-Grade Bonds: 

• Pros: Higher capital safety, dependable liquidity during downturns in the market and predictable generation of income. 
• Cons: Yields may not be able to combat aggressive inflation over longer durations. 

Junk Bonds: 

• Pros: Higher potential yields that may enhance overall portfolio returns; may support more refined asset diversification. 
• Cons: Higher volatility, vulnerability to economic shocks, and a higher risk of substantial or total capital loss in the event of default, depending on the security's seniority, collateral, and recovery value. New retail investors should take these cautiously, approaching them via specialised platforms or managed debt mutual funds (instead of going for concentrated and direct choices). 

Benefits of Junk Bonds

Some of the core benefits of junk bonds for investors include the following: 

• Higher and Attractive Yields: These bonds typically pay higher yields than comparable higher-rated debt, although the actual yield varies by issuer, rating, maturity, and market conditions. 
• Appreciation of Capital: If the issuing company improves its financial standing or receives a credit rating upgrade, the bond’s market price may rise considerably. It may eventually lead to sizeable capital gains. 
• Diversifying the Portfolio: Adding high-yield debt to a portfolio of secure Government securities or equities may provide diversification, although adding lower-rated debt also increases portfolio credit risk. This is because performance patterns differ from those of other asset classes. 
• More Priority Over Equity: In case of any company bankruptcy or liquidation, debt holders generally have priority over equity holders in a liquidation, although the actual recovery depends on the security's seniority, collateral and the applicable insolvency process

Here are some of the advantages for the issuing companies: 

• Alternative Funding Options: Companies with weaker balance sheets, new startups, or even those recovering from earlier financial stress benefit from these bonds. They may have limited access to traditional bank financing or higher-rated debt markets. Hence, junk bonds can provide crucial working capital. 
• Operational Flexibility: Issuers can use the raised capital to expand their business, refinance existing and costlier debt, or work on major projects. 

Risks of Junk Bonds

Junk bonds in India carry higher risks of default and capital losses because they are mostly issued by unstable companies or startups with lower credit ratings. Some of the biggest risks of these bonds include: 

• Higher Default Risks: High-yield debt issuers may face financial struggles, stress or unstable cash flows. If the company faces bankruptcy or an economic downturn, it may not be able to make timely coupon payments or return the principal at maturity. In some scenarios, this may lead to a total loss of invested capital. 
• Liquidity Constraints: These instruments may suffer from lower trading volumes in the secondary markets than Government securities or corporate bonds with AAA ratings. Hence, during any financial crisis or market volatility, finding buyers may be tougher, forcing you to sell the bond at a hefty discount. 
• Price Volatility: Bond values can fluctuate sharply based on sectoral headwinds, corporate performance, and shifting macroeconomic factors and indicators. Higher volatility may make you vulnerable to sudden capital depreciation as a bondholder. 
• Sensitivity to Interest Rates: When broader market interest rates rise, existing fixed-coupon junk bonds become less attractive, causing their market prices to fall. Higher rates may also increase borrowing costs for vulnerable issuers. This escalates their probability of default. 
• Downgraded Credit Ratings: A rapidly worsening financial environment or outlook may trigger sudden rating downgrades. A downgrade may trigger selling by investors whose mandates, internal policies or regulatory requirements restrict holdings below specified rating thresholds. Such selling can put downward pressure on bond prices.

Junk Bonds in India: How the Market Actually Works

Understanding how the market actually works for junk bonds in India is very important. They are officially called non-investment-grade or high-yield bonds, representing debt rated BB+ or lower by leading credit rating agencies. The term junk is an informal market term which indicates speculative-grade or non-investment-grade debt. 

In reality, these are high-reward, high-risk financial instruments. Unlike the United States, where the high-yield bond market is more liquid and vast, the junk bond environment in India is shaped by structural challenges, regulatory limitations, and specific institutional behaviour. Let us first analyse the core aspects to help you get a broader picture. 

• Rating Aspects: 

• Credit rating agencies in India, such as ICRA, CRISIL and CARE, will assign ratings to issuers, ranging from AAA (highest level of safety) to D (default). 
• Investment-grade bonds are rated from AAA downwards to BBB- and are perceived as relatively safer. 
• Non-investment-grade or junk bonds are rated BB+ or lower. 
• With the AAA-obsession historically prevailing in India, these companies often find themselves excluded from regular institutional funding. This structural exclusion underpins how the junk bond market functions in India. 

• The Market Workings/Ecosystem: 

The extent to which regulated institutional investors can invest in lower-rated debt is determined by the regulations that apply to the investor and by the particular investment vehicle in question.

For instance, mutual funds are governed by SEBI's investment restrictions and therefore cannot be regarded as a general means of financing for non-investment-grade debt.

• Primary Issuers: 

• These companies issue high-yield debt in the country and usually fall into three segments. 
• The first segment is stressed or restructured corporates, i.e. firms going through any operational turnaround or recovering from debt restructuring. 
• The second is promoter-led or mid-sized companies, i.e. fast-growing entities that have already exhausted their bank credit. They lack the track record or scale to get investment-grade ratings. 
• The third is real estate and infrastructure developers that banks view unfavourably. This is because these sectors have longer gestation periods and more volatile cash flows. 

• Private Placement Route: 

You will rarely find a junk bond issued to retail investors through a public prospectus. A significant portion of corporate debt issuance in India takes place through private placements, although lower-rated debt can also be issued publicly or become available through secondary-market transactions, subject to applicable regulations.

Issuers sell these bonds directly to a select group of sophisticated, experienced investors. It avoids the stringent time, disclosure requirements and marketing expenditure linked to public issues. 

• The Actual Buyers or Capital Providers: 

These are the actual buyers of the bond in most cases: 

• AIFs (alternative investment funds): These are usually Category II AIFs that focus on structured credit or special situations. Certain AIFs, family offices, HNIs and other specialised investors may participate in structured-credit or special-situation transactions. 
• FPIs (foreign portfolio investors): Global distressed debt funds and other private equity firms actively buy bonds in this segment. They do so because they often seek arbitrage opportunities or emerging-market exposure with higher yields. 
• Distressed Assets Funds and ARCs (asset reconstruction companies): They often buy these bonds, sometimes as part of a strategy to gain more control or restructure struggling entities. 

*Retail investors may directly purchase high-yield or lower-rated NCDs via brokers with demat accounts at times. Some may also purchase through SEBI-registered OBPPs. 

3. Structural Attributes of High-Yield Debt in India: 

The internal dynamics of Indian junk bonds may differ considerably from their counterparts in the US. 

Since secondary-market liquidity can be limited for lower-rated or less actively traded securities, investors cannot easily sell these bonds in case the company’s financial health declines. Hence, transactions have become more structured in recent times.

Investors seek to safeguard themselves by asking for collateralisation, i.e., pledging promoter shares, personal guarantees from company founders, or charging land assets. 

Many Indian bonds may also have warrants or equity kickers. This may allow lenders to convert part of their debt into company equity if the firm successfully executes a turnaround, thereby enhancing overall returns. 

4. Risks, Rewards and Regulatory Aspects: 

The main attraction for investors in the Indian high-yield market is the desirable returns. In an ecosystem where AAA corporate bonds may provide 7-8% returns, junk bonds may routinely offer a higher expected yield than comparable higher-rated debt. 

Yet major risks remain, as the Indian market is highly vulnerable to macroeconomic volatility and shocks, along with liquidity constraints. The market’s structural fragility was evident during the DHFL and IL&FS crises. In these scenarios, BBB-rated debt was downgraded overnight to junk, leading to huge write-offs by mutual funds and locked-up capital. 

The SEBI and RBI (Reserve Bank of India) track this segment cautiously. To safeguard retail investors, SEBI has introduced measures to facilitate wider participation in the corporate bond market, including allowing certain corporate debt securities to be issued at a face value of ₹10,000 subject to specified conditions. This ends up ensuring that high-net-worth or institutional investors enter the segment, i.e. those who can afford capital losses.

The junk bond market in India bridges the gap between high-risk corporates seeking capital and sophisticated, more aggressive investors seeking higher yields. It is a market dominated by bespoke structuring, aggressive collateral enforcement, and deeper credit evaluation. 

What Happens if a Junk Bond Defaults?

When a junk bond defaults by missing an interest or principal payment, it triggers a structured market recovery and legal process. 

Instant Market Action: 

• Credit Rating Downgrade: If an issuer defaults on a rated debt obligation, the relevant CRA may revise the rating to the applicable default category. This may trigger major secondary-market panic and steeper markdowns. 
• Debenture Trustee’s Role: A compulsory Debenture Trustee will step in, representing the collective interests of the bondholders rather than the company. The trustee will assess whether the debt is unsecured or secured. 

Recovery and Resolution Pathways: 

• Security Enforcement: If the junk bond is secured by specific company receivables or assets, the trustee may initiate steps to sell or liquidate those assets. The proceeds will be used to repay the investors. 
• Insolvency Proceedings (NCLT): If recovery is not feasible, or if the issuer fails to pay, the trustee or other financial creditors must take further steps. They may petition the NCLT (National Company Law Tribunal) under the IBC (Insolvency and Bankruptcy Code). 
• Restructuring Debt: Often in Indian markets, especially with NBFCs (non-banking financial companies) facing asset-liability mismatches, issuers try to negotiate extra time or revised terms with creditors. This attempt happens outside the legal or court system instead of instant liquidation. 

Outcomes for Investors: 

• Partial Recovery: The total loss is not guaranteed in this case. Secured creditors may have access to the specified collateral, but actual recovery depends on the value and enforceability of the security, competing claims, costs and the applicable recovery or insolvency process. 
• Haircuts and Delays: Resolution via the NCLT mechanism may take considerable time, depending on the case and applicable legal process. It freezes overall liquidity and forces investors to accept major haircuts or reductions in the principal owed to them. 

Junk Bonds as a Market Risk Indicator

Junk or high-yield bonds are often perceived as key economic indicators in the Indian market. They can help measure investor risk appetite, market liquidity, and corporate financial health through yield spreads. Let us take a closer look at some of these aspects in more detail below:

• Widening Spreads: When the gap widens rapidly between safer Government securities (G-Secs) and riskier corporate bonds, it may signal economic stress. This may clearly indicate that investors are already anxious about tighter liquidity, default risk, or even slowing growth. 
• Narrowing Spreads: Whenever the gap shrinks between secure Government securities and riskier corporate bonds, it may indicate higher market confidence. This means investors are feeling more positive about business revenues. They are also more willing to lend to these weaker companies for a smaller reward. 
• Rates and Liquidity: Rising interest rates, higher inflation, and banking sector stress may lead to higher borrowing costs. This may push the high-yield spreads even wider. 

This matters immensely for the Indian market, since wider credit spreads mean higher borrowing costs for growing or expanding companies. It may also slow overall business investment.

At the same time, tracking these yields also offers an early glimpse into the actual-economy cash flow of sectors excluded from regular bank credit. This matters because several NBFCs (non-banking financial companies) and mid-tier entities depend on alternative high-yield debt platforms. 

Who Can Consider Junk Bonds?

Junk bonds, or non-investment-grade bonds, are usually suitable only for investors with a higher risk appetite. These are more aggressive investors who want higher yields and portfolio diversification and are willing to take on sizeable risks. Here’s who can consider investing in junk bonds and who should consider avoiding them. 

Who Should Avoid Investing in Junk Bonds 

Here are the investor types who should consider avoiding investing in junk bonds: 

Checklist Before Investing in a Junk Bond

Let's go deeper with a checklist before investing in a junk bond. 

1. Check the Credit Rating: Closely review the ratings and rationale letters from SEBI-registered credit rating agencies (ICRA, CARE, or CRISIL). Any rating of BB+ or lower indicates high speculative risk and the possibility of missed interest or principal payments. 
2. The Financial Health of the Issuer: Carefully review the bond issuer's balance sheet, overall cash flows, and profit and loss statements. Analyse the leverage ratio and also the Interest Coverage Ratio (this monitors the ability of the company to pay interest on its debt). 
3. Seniority and Security: Confirm whether the bond is secured by physical assets or is unsecured. Note that secured bonds always rank higher in repayment priority if the company files for bankruptcy. 
4. YTM (Yield vs Risk): Check the YTM (yield to maturity) instead of only the headline coupon rate. YTM reflects your total anticipated return based on the current market price and remaining cash flows. 
5. Trading Volume and Liquidity: You should check carefully whether the junk bond is traded actively on the secondary markets. Bonds with lower ratings may have lower liquidity. This means you may find it hard to sell them swiftly without accepting heavy price discounts. 
6. Industry and Macro Outlook: Evaluate the economic conditions and industry-specific outlook or health. Declining or cyclical sectors may have a higher risk of defaults during economic downturns. 
7. Diversification of the Portfolio: Limit concentration risk by spreading smaller allocations across multiple issuers and sectors. Avoid putting all your capital into a single instrument, even if the yields seem more attractive. 
8. Regulatory and Platform Verification: In case you are purchasing via online platforms in the Indian market, some basic checks are mandatory. These include the OBPP’s registration with SEBI and the 12-digit ISIN on depository portals (CDSL or NSDL). 

Taxation of Junk Bonds in India

If you decide to invest in junk bonds in India, understanding their taxation is also important. Junk bonds do not have a separate taxation category in the country. Instead, they follow the same tax rules that apply to NCDs (non-convertible debentures) or corporate bonds. Here is the overall framework for taxation that you should know about: 

• Coupon Payments or Interest Income: 

• Junk bonds offer considerably higher interest rates to compensate for their higher risk of default. Hence, the tax effect on interest income matters a lot. 
• The interest that you earn will be classified as Income from Other Sources. It is taxed as per your applicable income tax slab after being added to your income. 
• So, if you are in the highest income tax bracket (30%), almost a third of the yield will go towards paying taxes. 
• Issuers deduct TDS (tax deducted at source) at a flat rate of 10% on interest payouts under Section 193 of the Income Tax Act. However, this is only when the annual interest crosses ₹10,000. The TDS rate will increase to 20% if you do not provide a valid PAN (Permanent Account Number). 

• Capital Gains Taxes: 

• If you sell the junk bond in the secondary market or on an exchange before maturity, the profit will be subject to capital gains tax. This depends on the bond's listing status and your holding period. 
• For listed junk bonds, holding periods of 12 months or less will attract STCG (short-term capital gains) taxes. They will be taxed at your individual income tax slab rate. For holding periods of more than 12 months, LTCG (long-term capital gains) tax applies at 12.5%, minus any indexation benefits. 
• For unlisted junk bonds with holding periods of any duration, STCG (short-term capital gains) will apply. Therefore, any capital gains from the sale, transfer, or maturity of unlisted junk bonds are treated entirely as short-term capital gains and taxed strictly at your applicable income tax slab rate, whether you hold them for 1 month or 5 years

• Defaults and Capital Losses Tax Treatment: 

• Junk bonds have an intrinsically higher risk of default. If a company defaults on payments or goes into liquidation, investors should understand how the taxation framework handles losses. 
• If you sell a junk bond at a sizeable discount in the secondary market because of financial distress, the resulting capital loss may be used for tax-loss harvesting. Short-term capital losses may offset both long-term and short-term capital gains. However, long-term capital losses may offset only long-term capital gains. 
• If the issuer fully defaults and the bond becomes worthless, it can be complex for retail investors to treat it as a business loss or claim tax deductions. The tax treatment of a security that becomes worthless without a conventional transfer can be complex. Whether a capital loss can be recognised depends on the facts, the legal extinguishment or transfer of rights and the applicable provisions of the Income-tax Act. 

Conclusion

Junk bonds potentially offer higher yields to offset their higher default risk. However, as an investor, it is wise to keep them limited to a nominal part of the portfolio, rather than the foundational core. Even within this nominal allocation, diversification across issuers and sectors is also recommended to spread risk. Following a basic investor checklist is also important, including checking the credit rating, whether the bond is secured, and whether the online bond platform provider (if you’re choosing from here) is SEBI-registered. 

Disclaimer: This blog is solely for educational purposes. The securities/investments quoted here are not recommendatory.