Bonds rated BB plus or Ba1 and below, carrying meaningful default risk and paying a wide spread over governments to compensate for it.
High yield behaves more like equity than like rates. Spreads widen when earnings deteriorate and narrow when risk appetite returns, and the correlation with stocks is high enough that HY spreads are a standard risk sentiment gauge.
The two questions that decide returns are the default rate and the recovery-rate. Expected loss is roughly the product of the two, and the spread is only attractive if it exceeds that expected loss plus a liquidity premium.
Example: a BB index trades at a 320 basis point spread. With a 3% annual default rate and 40% recoveries, expected credit loss is 3% x (1 - 0.40) = 180 basis points, leaving 140 basis points of genuine compensation.
Original diagrams for the ideas on this page. Illustrative, not real market data.
The bid-ask spread. Buy orders sit below, sell orders above, and the gap between the best bid (50.01) and best ask (50.04) is the spread you pay to cross. Bar length shows the size resting at each price.Equity curve and drawdown. An account balance plotted month by month. The fall from the $16,000 peak to the $12,000 trough is a 25% drawdown, and the shaded area lasts until the balance climbs back to the old peak.
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