INTRODUCTION
This research examines leveraged buyouts (LBOs). Specifically, it attempts to determine whether or not LBOs are either good or bad for the American economy.
LEVERAGED BUYOUTS AND JUNK BONDS
LBOs and their effect on the American economy cannot be adequately discussed without also considering junk bonds. The reason for this necessary linkage is that junk bonds are used to finance LBO deals.
A leveraged buyout is one in which the cost of the purchase is largely borne by the firm being acquired. In most instances, these deals are structured to be financed by so called junk bonds.
Junk bond is the term used to describe an (1) original issue, (2) high yield, (3) low grade, (4) corporate bond (Weinstein, 1987, p. 76). In the context of high and low grade, this definition is generally applied so that the lowest ranked bond which would be included in the high grade classification would be Moody's Baa (Weinstein, 1987, p. 76).
Junk bonds, thus, are, generally speaking, those original issue corporate bonds which are below investment grade. Investment grade bonds are typically considered to be bonds included in the high grade classification.
Low grade bonds are generally associated with higher risk levels than those which characterized high grade, or investment grade, 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 (Worthy, 1987, p. 59).
The junk bond market developed as an alternative to the private placement of high yield, high risk bonds (Worthy, 1987, p. 59). The development of the junk bond market marked the occurrence for the first time since pre 1929 crash days of public purchases at a significant level of less than investment grade fixed income securities (Weinstein, 1987, p. 76).
The investm...