Final answer:
A company fails to meet the terms of the indenture, it is considered to be in default. Default may lead to bankruptcy proceedings initiated by the bondholders. Investors can reduce risk via diversification, even with junk bonds.
Step-by-step explanation:
When a company that has issued bonds fails to adhere to the obligations set out within the indenture, such as making scheduled payments to bondholders, the company is considered to be in default. Defaulting on bond payments does not necessarily mean that the company is bankrupt, though bondholders do have the right to force bankruptcy proceedings in an effort to recoup their investments. Companies aim to avoid default due to the significant negative implications it can have on their financial standing and reputation.
Focusing on a diversified investment strategy can mitigate risk for bond investors. By holding bonds from a range of companies, investors protect themselves because not all companies are likely to go bankrupt at the same time, even among those issuing higher-risk junk bonds.