junk bond

"Why is this bond paying 18 percent when the government one is only paying 14?" Tunde asked his cousin, who works at an asset management firm in Lagos.

"Because nobody trusts that company to survive the next five years," his cousin replied. "The extra interest is them begging you to take the risk."

That, in one exchange, is the whole story of a junk bond. When a company borrows money by issuing a bond, rating agencies grade how likely that company is to pay it back on time. A strong company like a big bank or a stable manufacturer gets a good grade, and can borrow cheaply because lenders feel safe. A weaker company, maybe one carrying too much debt already or operating in a shaky industry, gets a poor grade. Lenders will still lend to them, but only if the reward is big enough to make the gamble worth it. That poorly graded, high interest bond is what people call a junk bond, though the polite name in finance circles is a high yield bond.

Say a struggling Nigerian real estate firm wants to raise ₦2,000,000,000 to finish a stalled housing project. Banks are wary because the company has missed payments before. So the firm issues bonds directly to investors, promising 20 percent a year, far above the 13 percent a safer company would offer. Investors who buy in are betting the project succeeds and the firm keeps paying. If it does, they collect a fat return. If the firm collapses instead, they could lose a good chunk of their money, sometimes all of it.

In the United Kingdom, junk bonds became infamous in the 1980s when companies used them to fund aggressive takeovers, borrowing heavily on the promise of future profits that did not always arrive. The lesson has never changed since then. High reward on a bond almost always means high risk sitting calmly underneath it, and the two travel together whether the bond is issued in London, Lagos, or anywhere else.