Question

investment grade bonds vs. junk bonds

what do you think happened in 2008...did we rate junk bonds as grade bonds? (200-250 words)

Answer 1

Junk bonds are also known as high yield bonds and these bonds are rated below the investment grade by the rating agencies. This is because of the fact that junk bonds carry a higher risk of default when compared to other bonds. For this the junk bonds pay higher returns to make them attractive for investors. Thus junk bonds are high risk high return bonds while investment grade bonds have high ratings and lower level of risk.

Now what happened during the 2008 financial crisis was that may of the toxic assets (i.e. assets which did not had any intrinsic value of their own and were highly risky) were linked to the junk bonds and high yield corporate bonds. The 2008 financial crisis occurred because the junk bonds and other subprime and high yield assets were sold as AAA rated bonds. What happened due to this that an artificial market was created due to this system of rating junk bonds as graded bonds and this created a big bubble. The bubble burst and when it did the crisis hit. When the crisis hit the junk bond yield prices fell and this led to the skyrocketing of their yields. This led to increase in YTMs (i.e. yield to maturity) of junk bonds by as much as 20%. This would not have occurred if the junk bonds were not rated as grade bonds.

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