What is typically the risk associated with junk bonds?

• A. Low potential returns
• B. Moderate liquidity
• C. High risk of default
• D. Guaranteed returns

Answer: (C)

Junk bonds, also known as high-yield bonds, are debt securities issued by entities with lower credit ratings. The primary risk associated with junk bonds is indeed the high risk of default. This means that the issuer of the bond may not be able to make the promised interest payments or repay the principal amount upon maturity. The lower credit ratings reflect the issuer's perceived inability to manage financial obligations, making them more susceptible to economic downturns or business failures.

The higher yields offered by junk bonds are designed to compensate investors for this increased risk, as they provide a potential for greater returns compared to investment-grade bonds. However, the trade-off is substantial; investors must be aware that their investment is at a higher risk of loss compared to more stable bonds.

In contrast, the other options do not reflect the characteristics of junk bonds accurately. For instance, junk bonds are known for having high potential returns due to their higher yields, not low returns. The liquidity of junk bonds varies but is generally considered moderate rather than a distinct feature. Lastly, there are no guarantees on returns for any type of bond, especially junk bonds, which carry significant risk. Therefore, the high risk of default is the most defining and relevant risk associated with junk bonds.