High Yield Bonds (PowerPoint) by dfhdhdhdhjr


									High Yield Bonds
      Christina Woo
    BA 543- Evening
      May 12, 2005
Risk v. Reward

Balancing act between desire for low risk
 and for high returns
Balance between:
  Low risk Low payoff
  High risk High payoff
Risk: uncertainty
Bond risk: possibility of default
Reward: monetary payout
High Yield Bond Risk
 Maximum return is the coupon and face value
 Loss is total investment amount
 Risk shifted to investors
 Historically, the longer out the maturity date is,
  the more risk, the more return
 4 types of risk
   Economic risk
   Interest rate risk
   International risk
   Market specific risk

Alexander Hamilton
  First to issue “junk securities” in the US
Allowed smaller companies/large investors
 to use the bond market to finance
Finance companies who’s industries had
 limited access to capital markets
History cont.

1970s: modern era
1980s: record number of
 buyouts/recapitalizations = market crash
1990s: issues increased
2002: market collapsed due to recession
Due to Milken and others, government
 established policies that companies can
 only invest in investment grade bonds
Michael Milken

Drexel Burnham Lambert
  Michael Milken, “Junk Bond King”
  Went looking for companies who needed capital
   to grow their business & were willing to add
   debt to balance sheet
  Got companies to issue $2.5B high yield debt at
  “Unethical practices”
Michael Milken cont.

Found guilty for violating federal securities
 and racketeering laws
Charged with insider trading
Banned from working in securities
Decided to become consultant
  SEC fined $42M+interest
Now runs cancer foundation
High Yield Bonds
Type of bond that companies use to gain
  Loomis Sayles Institutional HIG 17.2% annual
Aggressive business development
  Allows corporations to issue long term fixed rate
“Junk” Corporate Bond Rating System
How high yield bonds are rated

Traded on public market so market
 establishes interest rate
Original-issue high-yield bonds
Downgraded bonds
  Fallen Angels
    Issuer voluntarily increased debt
    Poor company performance
    Unable to repay back debt
  Voluntarily downgraded
Recent Fallen Angles

General Motors
  April 5, 2005 Moody downgraded GM’s bond
   rating to Baa3
  Rating shifted to Baa2
May 6, both GM and Ford bonds
 downgraded even further to “junk” status
Voluntary Bond Downgrade

Leveraged buyouts/recapitalizations
  Takeover of RJR Nabisco in late 1980s
  After takeover occurred, company’s debt
   increased dramatically when compared to its
  Investors demanded higher payouts to
   compensate for the risk
Bond Ratings Change

Event Risks
  Corporate restructuring
  Change in business
Leveraged Buyouts
  Need to service large amounts debt, bond
   quality rating decreases
    CF constraints
    Companies issue bonds with deferred coupon
     payments to delay using cash to pay interest
Deferred Coupon Structures

Deferred-interest bonds
  Sell discount, do not pay interest for initial
Step-up bonds
  Coupon rate initially low, then gradually
  Gives issuer option to pay cash at coupon
   payment date, or give another bond
Who uses high yield bonds

“Rising Stars”
Companies with high credit risk
  Market dictates that these firms pay higher
   interest rates back to investor
High yield bond market share:
  Manufacturing: 31.9%
  Radio/Television: 11%
  Electric service: 7%
How to invest in high yield bonds

Mutual funds
  Several different bonds combined together
     Diversifies investor’s bond portfolio
     Investor’s money not directly tied to high yield bond
Shorter bond length, less risk, less return
  Depends on bond and rating
  Bonds called within one year, 2-14% return
  Bonds called after 3 years, around 20% return

Yield rates dropping
  25.7% September ’03 to 12.22% December ’03
Default rates decreasing
  27 issuers globally on $5.4B, 1996
  Second lowest in 10 year window
  Manufacturers defaulted the most
Good investment?

Spread between speculative and
 investment grade market decreasing
1996, returned 12.4% average to investors
Helped to support gains in speculative
 grade market
Warren Buffet seen looking into high yield

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