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In finance, a 'high-yield bond' ('non-investment grade bond' or 'junk 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.

Contents

Flows and levels

Risk

Usage

High-yield bond indices

Citations

See also

External links

Flows and levels

Global issuance of high yield bonds more than doubled in 2003 to nearly $146 billion in securities issued from less than $63 billion in 2002, although this is still less than the record of $150 billion in 1998. Issuance is disproportionately centered in the U.S.A., although issuers in Europe, Asia and South Africa have recently turned to high yield debt in connection with refinancings and acquisitions. In 2006, European companies issued over €31 billion of high yield bonds.^[1]

Risk

The holder of any debt is subject to interest rate risk and credit risk. Interest rate risk refers to the risk of the market value of a bond changing in value due to changes in the structure or level of interest rates or credit spreads. The credit risk of a high yield bond refers to the probability and probable loss upon a credit event (i.e., the obligor defaults on scheduled payments, files for bankruptcy, or the bond is restructured.)
A credit rating agency attempts to describe the risk with a credit rating such as AAA. In the North America, the five major agencies are Standard and Poor's, Moody's, Fitch Ratings, Dominion Bond Rating Service and A.M Best. Bonds in other countries may be rated by US rating agencies or by local credit rating agencies. 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 and bonds issued by government sponsored enterprises (GSE's) 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-" or "AA+".
Bonds rated BBB- and higher are called investment grade bonds. Bonds rated lower than investment grade on their date of issue 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 (banks, insurance companies), 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 have a different investor base/clientele than investment grade bonds.
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 may drop, and the drop in interest rates tends to increase the value of investment grade bonds; however, a recession tends to increase the possibility of default in junk bonds.

Usage

Junk bonds became ubiquitous in the 1980s, through the efforts of investment bankers like Michael Milken and Drexel Burnham Lambert, 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.
In 2005, over 80% of the principal amount of high yield debt issued by U.S. companies went toward corporate purposes rather than acquisitions or buyouts.
High-yield bonds can also be repackaged into collateralized debt obligations (CDO), thereby raising the credit rating of the senior tranches above the rating of the original debt. The senior tranches of high-yield CDOs can thus meet the minimum credit rating requirements of pension funds and other institutional investors despite the significant risk in the original high-yield debt.

High-yield bond indices

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.

Citations

1. Bryant Edwards et al,[1]|High Yield In France] (Latham & Watkins LLP 2006)

See also

★ Bond market index

★ Thomson Financial League Tables

★ Distressed securities

External links

★ High Yield Blog

★ Thomson - Financial - League Tables

★ Junk bond

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★ 4Q03 Global Capital Markets Press