High Yield BondsXiong 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.

• 1984-1985the new issued high yield bonds were worth $14 billion and accounted for 22% of total corporate bond issued

• 1989-1990 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.

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 (1994-2007)

Average credit spread (1998-2007)

Characteristics

• The lower credit rating the higher yield to maturity

Junk Bonds

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 Quiz1. High yield bonds also called?

a) Investment-rated bondsb) Junk bondsc) James bond

2. Who is the Junk bonds king?a) Michael Jacksonb) Michael Milkenc) Michael Jordan

3. What is a Step-up bonds?a) Bonds sold at a deep discount and do not pay

interest for an initial periodb) Pay coupon interest at low rate for an initial period

and then increase to a higher ratec) Pay cash or a cash equivalent bond to bondholders

Questions?

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