What is the primary risk associated with junk bonds?

The primary risk associated with junk bonds is high default risk. Junk bonds, also known as high-yield bonds, are issued by companies that have lower credit ratings, often due to financial instability or a history of poor performance. Because these issuers are viewed as less likely to be able to meet their debt obligations, there is a greater chance that they will default on their interest payments or the repayment of the principal.

Investors are drawn to junk bonds primarily because of their potential for high yields, which compensates for the increased risk of default. While the potential returns can be attractive, it is essential for investors to be aware that the higher yield comes with the understanding that the issuer might not be financially sound enough to honor the bond agreements.

Other factors, such as liquidity and availability, may also play a role in the investment decision but are secondary to the fundamental risk of default that defines the nature of junk bonds. Understanding this risk is crucial for any investor contemplating an investment in this type of debt instrument.