Junk Bond Market

The research examines the rise and fall in the popularityof the socalled junk bond market in the United States. As junk bonds were and are issued in conjunction with leveraged buyouts (LBOs), this type of financial maneuver is also examined.

The term junk bond is used to describe an (1) original issue, (2) highyield, (3) lowgrade, (4) corporate bond.1 In the context of high and lowgrade, this definition is generally applied so that the lowest ranked bond which would be included in the highgrade classification would be Moody's Baa.2 Junk bonds, thus, are, generally speaking, those ori ginal issue corporate bonds which are below investmentgrade. Investmentgrade bonds are typically considered to be bonds included in the highgrade classification.

Lowgrade bonds are generally associated with higher risk levels than those which characterize highgrade, or

1M. I. Weinstein, "A Curmudgeon's View of Junk Bonds," Journal of Portfolio Management (Spring 1987): 76.

2investmentgrade, bonds. Thus, while junk bonds offer a higher potential return on investment, the risk that the investment will be lost through default is correspondingly higher.3

A leveraged buyout is a procedure whereby one firm is acquired by another. In a leveraged buyout, the cost of the purchase is largely borne by the firm being acqu

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through because of the impact on the junk bond market of the October 1987 crash.18 Junk bonds, other than those issued to finance leveraged buyouts, generally recovered a substantial part of their lost value by lateNovember 1987.19 By March 1988, the average __________ 16C. Farrell, "The Junkbond Market: Back From the Scrap Heap," Business Week, 28 March 1988, 102. 17Worthy, 59. 18Ibid. 19Ibid. 6 yield on these securities was back down to 13 percent (from the 14.5 percent immediate postcrash high).20 In the lasthalf of 1988, the junk bond market appeared tobe healthy.21 One troublesome sign for the future, however, was the American Brands deal involving its EII acquisition.22 Following the acquisition, American Brands offered to buy back EII junk bonds. The security holders, including Drexel Burnham Lambert held out for a higher offer. In a complicated deal, American Brands, a strong firm, managed to shift the responsibility for the EII junk bonds to the debtladen Riklis Family Corporation. Thus, the EII bonds, which were yielding under 10 percent, soon were yielding about 18 percent. The junk bond market plodded along for awhile. Soon, however, many of the firms saddled with the highinterest ju

Category: Economics - J