1. Financial Market Theory
Thursday, November 8, 2018
Professor Edwin T Burton

2. Cost of Capital For debt – just rate of interest on the debt
For equity – “the required rate of return” - paradoxical
If equity is cheap that means the required rate of return is high
If equity is overvalued, the required rate of return is low

3. Types of Financing Bank Debt Private Placements Public Debt
Insurance cos
Mutual funds
Public Debt
High Grade Investment Debt
Subordinated Debt
High Yield Debt
ABS Debt

4. High Yield Debt
Until 1978, all high yield debt had been originally investment grade corporate debt that went bad
Drexel (1978) initiated the high yield debt public offering market

5. The “New Offering” High Yield Debt Market
At first, simply “lower credit” public offerings of debt
Participated in only by Drexel Burnham
Other Wall Street firms refused to participate

6. The LBO Activity in the 1980s
Leveraged Buyouts
Done by “Corporate Raiders”
Financed by
At first, banks
Later, Drexel and high yield debt

7. The Rise of Drexel Burnham
In 1980 Drexel Burnham was a small beautique
By 1987, Drexel Burnham was the most powerful and profitable firm in Wall Street

8. Guliani on the attack July, 1987 Boesky pleads guilty
Probe moves to Milken and others
Early 1988 Drexel reports record earnings
Early $ 24 billion in RJR bonds financed by Drexel
Fall of 1988 Govt charges Drexel with Rico
Drexel takes bankruptcy

9. Early 1989 Milken reaches plea agreement Lowell will not be charged
Pleads guilty to “parking” securities
Sentenced to 3 years and $ million fine

10. Early 1990
Goldman, Morgan Stanley, Merrill Lynch, Salomon Smith Barney
Enter the “high yield” business
Put in charge – all former Drexel employees

11. High Yield Business Grew enormously from early 1980s to today
Still growing
Spreading to non-US
Returns far better than stocks

12. November 6, 2018