INTM524050 | Thin capitalisation: practical guidance: the use of credit ratings: the distinction between ‘investment grade’ and ‘speculative grade’

The market for non-investment grade or ‘speculative grade’ bonds

As indicated in INTM524040, debt with a credit rating below a particular level are termed non-investment grade, or “speculative grade” debt (also known more pejoratively as “junk debt”).

Although there is undoubtedly a market for such debt, the market is smaller. Furthermore, the market in these instruments is substantially less liquid than the market in investment-grade debt. As a consequence, institutional investors - who are the major lenders in the debt markets, will usually steer clear of the most speculative types of investment. Mutual funds and government-run pension funds often operate a policy restricting their investments to certain grades of debt, typically excluding those rated as speculative.

The tendency of major investors to avoid higher risk debt may mean that a debt issue may not be fully subscribed, so that there are risks for the borrower as well as the lender in trying to raise debt that is too speculative. Whether or not a debt issue is fully subscribed will also depend on aspects such as investor appetite for the sector and demand for debt with a particular maturity date.

Speculative grade debt is also known as high yield debt.