Chapter 15 in Brigham deals with the topic of long-term debt. The chapter first presents an overview of traditional debt instruments including term loans, different types of bonds and debentures. Specific features of debt contracts are then analyzed including agency problems for bondholders, call provisions and sinking funds. Recent innovations in bonds are then discussed including zero coupon bonds, floating rate debt and junk bonds. The chapter concludes with a more detailed discussion of bond ratings and the factors which influence long-term financing decisions.
Brigham defines a bond as a long-term contract under which a borrower agrees to payments of interest and principal on specific dates to the holder of the bond. Brigham notes that bonds are similar to term loans, but a bond issue is generally advertised, offered to the public and usually sold to many different investors. The chapter also points out that while bonds normally have a fixed interest rate, in recent years there has been an increase in the use of various types of floating rate bonds.
Brigham notes that junk bonds became quite popular in the 1970s. The chapter attributes the innovations in this instrument to Michael Milken of the former investment banking firm Drexel Burnham Lambert. According to the chapter, Milken, initially relied on the historical studies of W. Braddock Hickman (1958). They tended to show that risky bonds yielded more than enough to compensate for their risk. Armed with such evidence Milken began to convince certain institutional investors of the merits of purchasing risky debt. The analysis which follows will look more closely at the nature of junk bonds, the evidence supporting the Hickman data as well as the consequences for corporate America and the American financial system of its infatuation with "junk."
The introduction of high-yield (junk) bonds became a very important financial innovation with wide impact throughout...