Worth the risk? The appeal and challenges of high-yield bonds
High Yield Bonds Xiong Xiao. Agenda What is high yield bonds? The history of high yield bonds...
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Transcript of High Yield Bonds Xiong Xiao. Agenda What is high yield bonds? The history of high yield bonds...
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?
Thank You
Make Presentation much more fun