High Yield Bonds Xiong Xiao

Agenda What is high yield bonds? The history of high yield bonds Characteristics and structures of high yield bonds Importance of high yield bonds to corporate finance Summary

High yield bond Bonds issued by low credits rating company –Junk bonds or Noninvestment-rated bond or Speculative grade bond Normally issuers’ rating is lower than BBB(S&P) or Baa(Moody’s) High default risk and high return Downgraded bonds –Leveraged buyout/recapitalization –Fallen Angels

Bond rating system

History High yield bonds began in 1920’s~1930’s –Early issuers: IBM, General Motors etc. Late 1970’s-1980’s the golden period of high yield bonds –Government deregulation (Liberal economic policies) –Industry restructuring and reforming caused a huge wave of merger and acquisition Leveraged buyouts Michael Milken –Junk bond king –Believes that the rewards of HYB outweighed the default probabilities –Drexel Burnham Lambert Investment bank –Hostile takeover –Milken’s success sours –Dedicated to education industry & Prostate Cancer Foundation.

the new issued high yield bonds were worth $14 billion and accounted for 22% of total corporate bond issued the default rate of company increased rapidly due to economic downturn and excessive speculation. The high yield bonds market shrinked rapidly After 1991, high yield bonds market began to mature. Less speculative merger or acquisition, more capitalization and refinancing History Cont.

In 2011, high yield bonds account for more than $1 trillion

Characteristics The lower credit rating the higher default rate and credit spread Average default rate ( ) Average credit spread ( )

Characteristics The lower credit rating the higher yield to maturity Junk Bonds

Characteristics Return and risk are between treasury bond and stock

Structures Three types of deferred coupon structures: Deferred-interest bonds Bonds sold at a deep discount and do not pay interest for an initial period(3-7yrs) Step-up bonds Pay coupon interest at low rate for an initial period and then increase to a higher rate Payment-in-kind bonds Pay cash or a cash equivalent bond to bondholders

Importance to corporate finance Allows small or medium corporations to capitalize by issuing long term, fixed rate debt Shift the risk from taxpayers to specific bond investor group Investing public determine the interest rate base on company’s potential(unlike commercial bank base on credits analysis) Give corporation opportunity to get access to public funding

Summary High yield bonds issued by low credit rating companies High yield bonds have high default risk and high return High yield bonds market started in 1920’s and peaked in 1980’s and matured in 1990’s. Now high yield bonds account for more than $1 trillion Michael Milken—the Junk bonds king Three types of deferred coupon structures Deferred-interest bonds Set-up bonds Payment-in-kind bonds

Pop Quiz 1.High yield bonds also called? a)Investment-rated bonds b)Junk bonds c)James bond 2.Who is the Junk bonds king? a)Michael Jackson b)Michael Milken c)Michael Jordan 3.What is a Step-up bonds? a)Bonds sold at a deep discount and do not pay interest for an initial period b)Pay coupon interest at low rate for an initial period and then increase to a higher rate c)Pay cash or a cash equivalent bond to bondholders

Questions?

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