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High Yield Bonds ( Junk Bonds) and Their History

High Yield Bonds ( Junk Bonds) and Their History. Corey Bramlet. High Yield Bonds. A bond that is rated below investment grade Non-Investment Grade Speculative Grade “Junk” Lower-rated bonds involve more risk, and therefore offer higher yields

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High Yield Bonds ( Junk Bonds) and Their History

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  1. High Yield Bonds (Junk Bonds) and Their History Corey Bramlet

  2. High Yield Bonds • A bond that is rated below investment grade • Non-Investment Grade • Speculative Grade • “Junk” • Lower-rated bonds involve more risk, and therefore offer higher yields • The U.S. junk bond default rate 2010 – 13-14% • The U.S. junk bond default rate 2007 – less than 1%

  3. Ratings • JUNK

  4. Terminology • Original-Issue High Yield Bonds • A bond rated non-investment grade at time of issuance • Fallen Angles • Rated investment grade and has “fallen” to non-investment grade • Rising Stars • Non-investment grade and has “risen” to investment grade

  5. Buyouts • Leveraged Buyout (LBO) • The assets of the acquired company are used as collateral for the borrowed capital • Ironically a company’s success can be used against itself as collateral • Management Buyout (MBO) • A buyout led by existing management

  6. LBO/MBO - Pros and Cons Pros: • Improve market value and increase efficiency • Increased personal stake gives managers and employees incentive to succeed Cons: • High financial pressure - Increased risk of default • MBO gives existing management the incentive to devalue their stock ???

  7. Role of High Yield Bonds • Shift risk from commercial banks to the public investing market • Opportunity for a corporate segment to access a larger pool of funds • Market sets the interest rates

  8. Who can’t play? • Commercial Banks • Insurance Companies • Pension Funds • Prohibited in their bi-laws from investing in bonds below a particular level

  9. Drexel Burnham Lambert • Michael Milken “The Junk Bond King” • Realized fallen angels had regularly been valued less than what they were worth • Money raising ability facilitated the activities of leveraged buyouts (1980’s Boom) • "There is no shortage of capital; there is only a shortage of management talent“ • Indicted on 98 counts of racketeering and securities fraud in 1989 • Milken pleaded guilty to six counts of securities and tax violations in 1990

  10. Michael Milken (Continued) • 1993 – Milken diagnosed with prostate cancer • Today- • Founded Milken Family Foundation to support medical research and education • Founded the Prostate Cancer Foundation

  11. References • http://www.reuters.com/article/2010/03/04/defaults-bonds-moodys-idUSN0412669120100304 • http://en.wikipedia.org/wiki/High-yield_debt • http://www.moodys.com/ • http://en.wikipedia.org/wiki/Michael_Milken • http://money.cnn.com/2007/12/06/markets/junk_bonds/index.htm • Brealey, Myers, Allen. Principles of Corporate Finance 10th Edition, 2010 • Fabozzi, Modigliani, Jones. Foundations of Financial markets and Institution 4th Edition, 2010

  12. Questions ?

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