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1.
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Definition
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In
finance, a junk bond (or high yield bond) is a bond that is rated
below investment grade at the time of purchase. These bonds have a
higher risk of default or other adverse credit events, but typically
pay higher yields than better quality bonds in order to make them
attractive to investors.
Other Resources:
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Trader Soft:
A junk bond (or high-yield bond) is one with a credit rating of
BB or lower and that carries higher risk of interest or
principal default than better rated investment grade bonds.
More…
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Business.gov:
A high-yield corporate bond issue with a below-investment
rating that became a growing source of corporate funding in the
1980s.
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Mutual Fund Investor's
Center:
A speculative bond rated BB or below by Standard & Poor's
Corp. and Ba or below by Moody's Investor Service.
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HSBC:
Corporate debt that offers investors a high rate of interest
because of the perceived higher risk of default.
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HPOPS:
A
corporate bond having a high yield and high risk.
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A to Z Investments:
A bond with a rating of BB or worse that is considered to be
more volatile than higher rated bonds.
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India Infoline:
A high yield bond with a low rating and very low security.
More…
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Stock-investing-guru.com:
A lower-rated bond, on account of the fact it is accompanied by
a higher perceived risk, pays a greater yield.
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Parker Carlson & Johnson:
Junk bonds are bonds that are considered high yield but also
have a high credit risk. They are generally low rated bonds and
are usually bought on speculation, with the investor hoping for
the yield, rather than the default.
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Tripp & Co., Inc.:
A debt obligation with a rating of Ba or BB or lower, generally
paying interest above the return on more highly rated bonds,
sometimes known as high-yield bonds.
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University of Toledo:
This informal title was given to bonds often issued to finance a
corporate takeover and characterized by high yield and high
risk, with resulting concerns for both the issuing firm and the
investor.
More…
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Randolph Brooks Services
Group, LLC:
Bonds that have little or no collateral or liquidation
value and are typically very risky. For this risk, they offer a
high rate of return.
More…
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Freebuck.com:
A high-yielding corporate bond that is issued by a distressed
company. These are securities rated BBB or lower.
More…
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2.
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Examples, Types, or
Variations
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High-yield bond indices exist for dedicated investors in the market.
Indices for the broad high yield market include the CSFB High Yield
II Index (CSHY), the Merrill Lynch High Yield Master II, and the
Bear Stearns High Yield Index (BSIX). Some investors, preferring to
dedicate themselves to higher-rated and less-risky investments, use
an index that only includes BB-rated and B-rated securities, such at
the Merrill Lynch BB/B Index. Other investors focus on the lowest
quality debt rated CCC or distressed securities, commonly defined as
those yielding 1000 basis points over equivalent government bonds.
Other Resources:
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Find Articles:
There are two types of junk bonds: First are bonds that were
issued initially as investment-grade but through their
underlying firm's financial difficulties lost this high credit
rating.
More…
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3.
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Formula
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4.
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Related Terms
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Non-Investment Grade Bond
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Default Risk
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High
Yield Bond
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High
Yield Debt
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Fallen Angels
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Stub
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Vulture Fund
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Collateralized Bond Obligation
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Corporate Bond
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5.
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As
Used in the Hedge Fund World
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Other Resources:
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Investorama:
Mention junk
bonds to many investors and they'll flinch at the thought of
high-flying financiers of the 1980s such as Ivan Boesky and
Michael Milken.
More…
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Wikipedia:
Global issuance of high yield bonds more than doubled in 2003 to
nearly $146 billion in deals issued from less than $63 billion
in 2002, although this is less than the record of $150 billion
in 1998.
Junk bonds became ubiquitous in the
1980s,
through the efforts of investment bankers like
Michael
Milken, as a financing mechanism in
mergers
and acquisitions. In a
leveraged
buyout (LBO)
an acquirer would issue junk bonds to help pay for an
acquisition and then use the target's
cash flow
to help pay the debt over time.
Junk bonds are still used to finance
capital
intensive industries such as
telecommunications and oil and gas sectors.
Interestingly the bonds of companies such as Enron and Worldcom
were not initially rated as junk — Enron, because they hid much
of their debt in
off
balance-sheet transactions, and WorldCom, because
they understated their operating expenses while inflating
capital expenditures — so that the financial instability of the
company was not known to
credit
rating groups. Default swaps, which are essentially a
bet that a given company will go bankrupt, did trade at a
premium for Enron — an irony, given that the Houston company was
an early pioneer in trading them.
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6.
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Applications
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Other Resources:
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Wikipedia:
When analyzing the risk of a high-yield bond, it is important to
keep in mind that the expected return from a basket of high
yield bonds should approximate that of a similarly diversified
list of high grade bonds. The low-rated bonds offer higher
promised returns but have a higher expected probability of
default, which means that a greater proportion of their expected
return comes from interest payments rather than principal. As a
result, they are less sensitive to interest rate swings,
allowing a high-risk company to more easily refinance its debt
even if interest rates have increased. The analysis of
high-yield debt has much in common with equity analysis, because
the viability of the company and its future cash flows determine
whether it will be able to repay the debt. The value of a
company's equity is considered a cushion beneath the debt of the
company, as a company with highly valued equity is likely to
have the operational and financial ability to repay debt, and
can issue more of its stock for additional financing.
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7.
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Misused
& Abused
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Other Resources:
-
Wikipedia:
The
holder of a high yield bond is subject to
interest
rate risk and
credit
risk. Interest rate risk refers to the risk of a bond
changing in value due to changes in the structure or level of
interest rates. The credit risk of a high yield bond refers to
the probability of a default (i.e., debtor unable to meet
interest and principal obligations) combined with the
probability of not receiving principal and interest in arrears
after a default. A
credit
rating agency attempts to describe the risk with a
credit
rating such as AAA. In the
USA,
the three major agencies are
S&P,
Moody's and
Fitch
Ratings. Bonds in other countries may be rated by US
rating agencies or by local agencies like the
Dominion
Bond Rating Service (DBRS) in
Canada.
Rating scales vary; the most popular scale uses (in order of
increasing risk) ratings of AAA, AA, A, BBB, BB, B, CCC, CC, C,
with the additional rating D for debt already in arrears.
Government bonds are often considered to be in a
zero-risk category above AAA; and categories like AA and A may
sometimes be split into finer subdivisions like "AA (low)".
Bonds rated BBB and higher are called
investment grade bonds. Bonds rated lower than
investment grade are colloquially referred to as "junk" bonds.
The lower-rated debt typically offers a higher yield, making
junk bonds attractive investment vehicles for certain types of
financial
portfolios and strategies. Many
pension
funds and other investors, however, are prohibited in
their
by-laws
from investing in bonds which have ratings below a particular
level. As a result, the lower-rated securities may be harder to
sell. In some cases the limited market for junk bonds can lead
to a dismal cycle in which a company with financial difficulties
will have its bond rating lowered, and that makes it harder to
raise money, thereby deepening the company's financial troubles.
This cycle was one (but not the only) factor that accounts for
the sudden collapse of several high profile companies such as
Enron
and
WorldCom,
whose bonds were not initially rated junk.
The value of junk bonds is affected to a higher degree than
investment grade bonds by the possibility of
default.
For example, in a
recession
interest rates tend to drop, and the drop in interest rates
tends to increase the value of investment grade bonds; however,
a recession increases the possibility of default in junk bonds.
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8.
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Additional Sources of Information
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Books
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News
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Scholarly Papers
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Back to Terms
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