Junk Bond Creditworthiness

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Junk Bond Creditworthiness

Researching the credit of a company issuing junk bonds is the key to determining whether the bonds are a wise investment. This process is called credit analysis.

A company with strong management and sound financial strategy can often overcome a weak credit rating. Looking at a company’s profitability and asset value are good places to begin your research. It is also helpful to see how the rest of the company’s industry is doing. Compare the credit statistics of the issuing company with those of other companies in its industry.

Use ratios

Various ratios are also used in credit analysis. One example is the current ratio, the ratio of a company’s short-term assets to its short-term debts. The higher the current ratio, the lower the credit risk. A second example is the debt-to-equity ratio, a comparison of a company’s total debt to its overall stock value.

Look at maturity

Before buying a junk bond, you should also consider its maturity date, the time at which the bond must be repaid by the bond issuer.

The reason junk bonds offer higher yields is their greater likelihood of default. To avoid losing your money, it is important to have a clear understanding of the creditworthiness of the issuing firm and the factors that will impact its performance.