A junior security is a security which has a low priority when a business becomes insolvent and its assets are liquidated to cover its debts. Someone who holds a junior security must wait in line behind people with higher ranked securities and hope that assets are still remaining by the time the senior securityholders have been compensated. Most companies which issue securities offer junior and senior securities as investment options and standardized language is used to refer to securities, which makes it easy to determine whether a security is junior or senior.
A classic example of a junior security is common stock. If a company issues both preferred and common stock, the holders of preferred stock will be paid first if it goes out of business. If that company also issued bonds, they would be the senior security and those investors will be paid before holders of preferred stock. Since liquidating companies are usually short on assets, holders of junior securities run the risk of not having the debt made good and receiving a fraction of the former value of the securities they own.
There are reasons why investors might opt to purchase junior securities. Despite the fact that they may not be compensated if the company goes bankrupt, sometimes the risk is judged to be low. A company in good financial health with strong returns and a good performance history is not a likely candidate for bankruptcy, and thus such securities are relatively safe buys. Thus, an investor might find the risk worth it for the returns.
Because a junior security is riskier than a senior security, the return is higher. People can get a higher return on their investment by purchasing such securities and thus may be willing to gamble that a company is not going to go bankrupt or that if it does, they will be compensated for their losses. Potential investors can weigh the risks and benefits before the purchase to determine whether or not it is a sound buy.
When investing in a company, it is advisable to do some research to learn more about the company's security issues. Buying a junior security can vary in risk depending on how many issues the company has made and its history. Some buys may be more prudent than others. In addition to considering this issue, investors also look at things like the performance of the security in the past, general market trends, and other indicators which can determine whether or not an investment is sound.
