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					                     High Yield Bonds
                     And Their History

           “The point has always been to see the
           assets in the liabilities. To look beyond
             the debt and see what value really
            exists and how more can be created.”
                     - Michael R. Milken


                                            Presentation by
                                             Carl Toresson
02/18/09
                                                Joe Imatani
            Table of contents
• What is a high yield bond?

• Return and risk of high yield bonds

• The history of high yield bonds
               High-Yield Bonds
• Officially known as Noninvestment Grade Bonds
   • “Junk Bonds”


• Rated below S&P BBB or Moody’s Baa when
  purchased

• Pay a fixed coupon throughout its life and principal
  at maturity

• High Risk, High Reward
   Financing through High-Yield
               Bonds
• Originally, businesses were financed through
  bank loans
   • High interest rates
   • Short/Intermediate – term loans
   • Application denied

• Offers risky businesses financing options
   • Long-term debt
   • Fixed interest rates
   • Varying payment structures
                        Structures
• Deferred-Interest
   • Bonds that do not pay interest until after an initial
     period ranging 3-7 years

• Split Coupon (Step-up)
   • Bonds that pay an interest from the beginning, but
     at a low rate
   • Interest rates are increased after the initial period

• Payment-In-Kind (PIK)
   • Issuer has option to pay interest in the form of cash
     or a similar bond
    Return and risk of high yield
               bonds
• Analyzing high yield securities risk
   • Investors do not evaluate the default risk
     themselves, they rely on grades presented by credit
     rating agencies

• Return and the yield spread
   • The yield spread is the the extra yield that is
     provided above the risk-free interest rate
   • It is a compensation for taking the risk of providing
     the funds instead of placing them in risk-free T-bills
                 Yield spread
• Spikes occur
  when the market
  is unstable
  during a crisis

• The risk has
  often been
  overpriced
  historically
                  Question

• How would you exploit a situation where
  you realize that an investment has too
  high return compared to its inherent risk?
                      The Beginning
• High-yield bond issues began in 1920s
   • U.S. Steel
   • General Motors


• Companies using high-yield issues were
  predominately fallen angels
   • Bonds were paying low interest rates
   • Investors were averse to high-yield bonds
   • Companies were effectively shut out from the public market
                      Late 1970s
• Bretton Woods system of fixed exchange rates
  collapsed resulting in:
   • High inflation
   • High interest rates

• Oil chocks

• Commercial banks curbed lending to
  noninvestment grade companies

• 1977 – Bear Stearns and Company underwrote
  the first high-yield bond issue in decades
                       The 1980s
• Dramatic developments in the 1970s increased
  demand of financial innovation

• Michael Milken
   – As a student realized the high pricing of default risk in
     high yield bonds
       • Drexel Burnham Lambert - Raised money for badly rated
         companies by issuing high yield bonds

• Leveraged buyouts (LBOs)

• Advantages of high yield bonds
   • Without, commercial banks would lend the money,
     indirectly forcing the risk on U.S. Citizens

   • Possibility of long-term, fixed rate loan

   • Opens the possibility of funding for some firms that
     previously could not borrow money
Issuing volume 1982 - 2006
     The decline of the high yield
       market in the early 90s

• The downfall of the economy in the late 80s
  caused many firms to default on their loans

• The market for issuing high yield bonds
  disappeared

• Drexel went into bankruptcy (1990)

• Milken was sentenced to 10 years in prison for
  fraud
               Question

How do you think that the high yield
market has been, and will be, affected by
the current financial crisis?
                   Current State
• US Corporations accounted for 3/4ths of
  global corporate default in 2008
• S&P estimates that 209 companies will default
  in 2009 - 15 % of noninvestment market
• $760 billion worth of debt is set to mature this
  year
   • 40% of debt set to mature is noninvestment grade
• High-yield rates are estimated to average 17%
  during 2009
   • Investment grade bonds – 8%
Annual Default Rates
            Summary
- the role of high yield bonds in
        corporate finance
 A way for corporations with a current bad
  credit status to acquire funds they need to
                    develop
 Gives the opportunity to investors to earn
   a higher return - often better on risk-
     adjusted basis than investment graded bonds
  Cheaper way of obtaining capital than
                 equity
Question
As Michael Milken put it, the last century
has shown us that junk bonds put out a
higher rate of return compared to their risk,
so why does the skepticism against them still
exist?
Questions for us?

				
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