High yield bonds. An overview

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High-yield bonds or junk bonds originated in the United States where they were utilized in the
1980s to finance corporate takeovers. Essentially, they are are securities which have a poor
rating as determined by rating agencies, otherwise known as non-investment grade bonds.

And the issuers of these bonds typically do not meet the usual credit requirements for bonds.

As compensation for the higher risk involved with such bonds, they offer higher than average
interest coupons to make them more attractive to investors. With these investments, there may
be delays in payment or default.

Credit rating agencies distinguish the risk with credit rating such as AAA, AA, A, BBB, BB, B,
CCC, CC, C, with the additional rating D for debt already in arrears. Bonds rated BBB- and
higher are referred to as investment grade bonds, while those falling below that grade are
known as speculative grade bonds.

Bonds issued by the government or sponsored enterprises affiliated to it are usually regarded as
falling in the zero-risk category, that is above AAA.

For many years, emissions of high-yield debt were not open to the public, but tailored towards
institutional investors like insurance companies, through what is known as private placement.

The junk bonds themselves appeared in 1977 when the investment bank Bear Stearns
organized the first public offering of a bond issued by an issuer rated below investment grade.

A junk bond can be induced by the deterioration of the credit rating of the issuer during the term
of a loan. Countries are also rated by rating agencies and debt of nations with low credit ratings
on the bond market is identified as high-yield bonds.

The investment in junk bonds is part of speculative oriented portfolios. The direct purchase of
such financial products can be made at the usual exchange fees by private investors at any
time. The monitoring of performance by the private investor can be complicated due to high

In essence, the bearer of any debt is exposed to interest rate risk, inflationary risk, convexity
risk, streaming income risk, liquidity risk, default risk, etc. The credit risk of a high yield bond
pertains to the probability of incurring a loss on a credit event, or to the release of an adverse
credit quality update by the credit rating agency.

The junk bond market experienced a severe crisis in 1989 following the failure of several
issuers. Between the beginning of the year and the fall of 1989, the average yield junk bonds
rose from 450 basis points to over 1000 basis points over that of normal bonds. This increase of
550 basis points of credit spread represented a 20% decline in the price of loans.

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