An investment-grade bond has a significant portion of its yield-to-maturity (YTM) attributed to the government benchmark yield due to its strong ability to meet promised interest and principal obligations from operating cash flows.

High-yield bonds are issued by organizations that do not qualify for investment-grade ratings. High-yield issuers are characterized by a higher expected likelihood of financial distress. These issuers must pay a higher interest rate to compensate investors for the increased risks.

Given the higher chance of default, these instruments are more equity-like in nature and analysts place a great emphasis on the likelihood of default, potential loss given default, and the protections and secondary repayment sources that are available. Relative to investment-grade bonds, a higher portion of their bonds' YTM is attributed to an issuer-specific spread over the government benchmark yield.

Equity-Like Approach

Traditionally, high-yield bonds have provided a greater return than high-grade bonds, but lower than equities. Similarly, high-yield bond risk has been higher than that of investment grade bonds, but less than equities. High-yield bonds have historically been more highly correlated with equity securities than with investment-grade bonds. Thus, some analysts believe that an equity analysis approach will provide a better framework for high-yield bond analysis than a traditional credit approach.

An equity-like approach to high-yield analysis can be helpful. Calculating and comparing enterprise value with EBITDA and debt/EBITDA can show a level of equity "cushion" or support beneath an issuer's debt.