Junk Bonds

Junk bonds, also known as high-yield bonds, are nothing more than speculative grade (low-rated or unrated) bonds. Before 1977, almost all junk bonds were "fallen angels," that is, bonds issued by firms that originally had investment grade ratings but that had since been downgraded. In 1977, however, firms began to issue "original-issue junk."

318 Part THREE Debt Securities

Much of the credit for this innovation is given to Drexel Burnham Lambert, and especially its trader, Michael Milken. Drexel had long enjoyed a niche as a junk bond trader and had established a network of potential investors in junk bonds. Firms not able to muster an investment grade rating were happy to have Drexel (and other investment bankers) market their bonds directly to the public, as this opened up a new source of financing. Junk issues were a lower-cost financing alternative than borrowing from banks.

High-yield bonds gained considerable notoriety in the 1980s when they were used as financing vehicles in leveraged buyouts and hostile takeover attempts. Shortly thereafter, however, the legal difficulties of Drexel and Michael Milken in connection with Wall Street's insider trading scandals of the late 1980s tainted the junk bond market.

At the height of Drexel's difficulties, the high-yield bond market nearly dried up. Since then, the market has rebounded dramatically. However, it is worth noting that the average credit quality of high-yield debt issued today is higher than the average quality in the boom years of the 1980s.

Debt Consolidation Advice

Debt Consolidation Advice

This eBook will tell you the facts about Debt Consolidation and allow you to make an educated decision if you are considering consolidating your debts.

Get My Free Ebook

Post a comment