What contributes to the higher yields offered by junk bonds?

The higher yields offered by junk bonds are primarily due to the increased risk of default associated with them. Junk bonds, or high-yield bonds, are issued by companies or entities that have lower credit ratings. These lower ratings indicate a higher likelihood that the issuer may fail to make interest payments or repay the principal, which intensifies the perceived risk from the perspective of investors.

To compensate for this heightened risk, issuers of junk bonds offer higher yields than investment-grade bonds. This way, they attract investors who are willing to take on more risk in exchange for the potential of greater returns. The higher yield acts as an incentive for investors to invest in bonds that carry a significant chance of default, aligning with the basic investment principle that greater risk is often associated with the potential for greater reward.

Other options, such as low default risk, short-term investment horizons, and high credit ratings, do not accurately reflect the characteristics of junk bonds. All these aspects are typically found in more secure bonds, which in turn would yield lower returns due to their reduced risk profiles.