Benefit

  • 1. High yields can enhance your current income This yield premium is particularly attractive during periods of declining interest rates. Investors focus on the difference between yields on high-yield bonds and the yields on Treasury Bills.
  • 2. Security If a company is liquidated, bondholders usually have priority over stockholders in a company’s capital structure and are more likely to receive payment. The percentage of this payment compared with the original investment is called the “recovery rate.” As the table below shows, the holders of “secured debt” and “unsecured senior debt” have the highest claim on corporate assets in a bankruptcy distribution. Even the holder of a low-rated bond is entitled to a share of a failing company’s assets ahead of preferred or common stockholders.
    – Priority of Claims
    – Secured Debt Holders
    – Unsecured Senior Debt Holders
    – Other Unsecured Subordinated Debt Holders
    – Preferred Stockholders
    – Common Stockholders
  • 3. Portfolio risk diversification High-yield bonds are often considered a separate asset class, involving different characteristics from those of other securities. High-yield bonds can help you spread assets across different segments of the financial market, reducing your risk concentration in any one asset class in your overall portfolio.
  • 4. Less interest rate volatility risk than long-term Treasury bonds Prices of all market-traded fixed-rate bonds are affected by interest rates. If rates move up, bond prices move down (and vice versa). In general, the longer a bond’s maturity, the more vulnerable its price is to interest rate fluctuations. High-yield bonds are typically issued with maturities of 10 years or less, and are callable after four to five years. (masih perlu di revisi).
  • 5. Total return performance The “total return” performance of high-yield bonds includes price changes and reinvested interest income. In general, high-yield bonds tend to produce attractive total returns when the economy is growing and interest rates are stable or declining.

Risk

  • 1. Credit Risk.

    Credit risk is the potential for loss resulting from an actual or perceived deterioration in the financial health of the issuing company. Two subcategories of credit risk are default risk and downgrade risk.

    • Default Risk Defaults occur when a company fails to pay an interest or principal payment to a debt holder as scheduled and as specified in the legal agreements, i.e. the indenture. The risk of default on principal or interest, or both, is greater for high-yield bonds than for investment-grade bonds. Bonds of companies in default may trade at very low prices, if they trade at all, and “liquidity” may disappear.
    • Downgrade risk Downgrades result when rating agencies lower their rating on a bond—for example, a change by Pefindo from a A- to a BBB+ rating. Downgrades are usually accompanied by bond price declines.
  • 2. Interest Rate Risk

    Interest rate risk affects fixed-income security prices, mainly when interest rates rise. Since prices of all market-traded bonds move counter to the direction of rates, rising rates cause bond prices to decline. Longer-maturity bonds are the most vulnerable.

  • 3. Liquidity Risk

    Liquidity refers to the investor’s ability to sell a bond quickly and at an efficient price, as reflected in the bid-ask spread. A difference may exist between the prices buyers are bidding and the prices sellers are asking on large, actively traded bond issues. The gap is often small, producing greater liquidity. As the spread rises on less actively traded bonds, so does liquidity risk. High-yield bonds can sometimes be less liquid than investment-grade bonds, depending on the issuer and the market conditions at any given time.

  • 4. EconomicRisk

    Economic risk describes the vulnerability of a bond to downturns in the economy. For example, in 2008, when the fuel price increased, causing inflation rise to 12%, force the Indonesian Government to increase interest rate up to 9%, the principal value and the total return of high-yield bonds declined significantly. Virtually all types of high-yield bonds are vulnerable to economic risk. In recessions, high-yield bonds typically lose more principal value than investment-grade bonds.

  • 5. Company and Industry “event” Risk

    Company and industry “event” risk encompasses a variety of pitfalls that can affect a company’s ability to repay its debt obligations on time. These include poor management, changes in management, failure to anticipate shifts in the company’s markets, rising costs of raw materials, regulations and new competition. Events that adversely affect a whole industry can have a blanket effect on the bonds of its members.