C O R E Y B RA M L E T

HIGH YIELD BONDS (JUNK BONDS) AND

THEIR HISTORY

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%

RATINGS

•

JUNK

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

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

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 ???

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

WHO CAN’T PLAY?

• Commercial Banks• Insurance Companies• Pension Funds

• Prohibited in their bi-laws from investing in bonds below a particular level

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

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

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

QUESTIONS ?