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High-Yield Bonds

High-Yield Bonds. ADMS 4501 Sajjad Akbar | John de Gray | Patrick Lim | Marwan Mamoun Sanoufi | Albert Suetin. Agenda. Introduction to High Yield Bonds Risk Factors Historical Analysis Current Macroeconomic Factors ETF Selections Conclusion. High-Yield Bonds Defined.

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High-Yield Bonds

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  1. High-Yield Bonds ADMS 4501 Sajjad Akbar | John de Gray | Patrick Lim | MarwanMamounSanoufi| Albert Suetin

  2. Agenda • Introduction to High Yield Bonds • Risk Factors • Historical Analysis • Current Macroeconomic Factors • ETF Selections • Conclusion

  3. High-Yield Bonds Defined Corporate bonds rated below BBB or Baa3 Referred to as speculative-grade or junk bonds Offer higher interest rates (coupons) than government bonds High Yield Bond ETFs are designed to track high yield bond indices

  4. Bond Credit Quality Ratings

  5. Why Invest in HY-Bonds? • Diversification • Enhanced Current Income • Capital Appreciation • Equity-like long-term return potential • Relatively low duration

  6. Main Risk Factors of High-Yield Bonds • Credit Risk: • Default Risk • Downgrade Risk • Interest Rate Risk

  7. Our Investment Objective • We are hoping to obtain an annualized return of approximately 5.70% over the next 12 months • Our ETF selections will justify this return

  8. Historical Analysis • Originally HY-bonds were used by small firms unable to receive investment-grade ratings • Firms used the bonds to finance M & A’s or leveraged buyouts

  9. Historical Returns • Typically outperform returns of investment grade bonds • 300-400 basis points of additional yield relative to government bonds

  10. Annual Return Comparison

  11. Risk Comparison

  12. High-Yield Bonds Today • Represent 25% of US corporate bond market • Used to finance capital for all general business activities • Significantly growing in the US and rest of the world

  13. Money supply & interest rates • Historically low interest rates • HY Bond Prices INCREASE as Interest Rates go DOWN • Longer the maturity of High Yield Bonds, Greater the interest rate risk

  14. High Yield Market Estimated Size: 1Trillion+ USD • Top Seller for last year with over 20% increase in size

  15. Increasing money supply through various Federal Asset Purchase Programs has had limited effect • QE I and QE II • Operation TWIST • Regulators trying to spur spending • Capital Markets making considerable anticipations of continued soft-policies • Growing interest rate risk in future due to historically low rates

  16. BofC Overnight Bank Rate at 1% • BofC resistant to steep interest rate hike • Steady Growth anticipated for Canadian Corporations

  17. Inflation & expected inflation • High Yield Bond spreads decrease as Inflation levels rise • Bleak Signs of Global Food Crisis, Supply Shortage in various Commodities • No signs of inflation in US after increasing money supply • Deflationary risks in US • US recently started targeting inflation as a policy measure • US inflation target at 2% until at least 2013Q2 • Inflation expected to be steady due to perceived deflationary risks by the FED

  18. Credit conditions

  19. Credit conditions GLOBAL CORPORATE DEFAULT SUMMARY Total Defaults (bil. $) Total Debt Outstanding (bil. $) 2009 265 627.70 2010 81 97.48 2011 53 84.26 Credit Analysis is the most important part of investing in High Yield Bonds Increased cash levels and low default rates provide an upside of possible rating “upgrade” for corporations Risk Factors: • Business Risk (sound financials despite weak growth) • Rise in Treasury Yields (Interest Rates) • Rise in Inflation and Expected inflation • Continued Sovereign Debt Crises in Europe and US Best Approach: Bond-by-Bond Credit Analysis and stay Short-Term 1 to 4yrs

  20. Corporations in healthiest credit conditions • Liquidity injections by the FED • Cash-on-hand at record high (risk-averse and cost-conscious management strategies after ‘08 Financial Crisis) • Record low default rates among HY Bond Issuers • Corporate refinancing wave due to low rate environment • Strong yield spreads over treasuries

  21. High-Yield Bond ETF Selections • 50% of our investment is a long position in the American iBoxx $ High Yield Corporate Bond (HYG) ETF • 50% of our investment is a long position in the Canadian DEX HYBrid Bond Index Fund (XHB)

  22. HYG Industry Breakdown • 24% of ETF’s holdings have 1-5 years maturity time • 70% of ETF’s holdings have 5-10 years maturity time

  23. HYG Historical Returns

  24. Why HYG? • Good Tracking Error • Lower Duration, Maturity and Standard Deviation • Better bond ratings

  25. XHB Industry Breakdown • Over 71% of the ETF is invested in BBB rated bonds • 32% of ETF’s holdings have 1-5 years maturity time • 44% of ETF’s holdings have 5-10 years maturity time

  26. XHB vs Index

  27. XHB’s Year-to-date Performance • Open price: $20.56 • Price as of 11/25/2012: $21.15 • Monthly dividends averaging at $0.09 per share over the past year • Weighted Average Yield to Maturity: 4.62%

  28. Conclusion • Optimistic about HY-Bond given recent solid company earnings and reduced company defaults • Anticipate in the short term that interest rates will remain low • Equally splitting our investment into both Canada and the US achieves diversification • Given historical returns and anticipated steady growth, we predict an approximate return of 5.70% to be reasonable over the next year

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