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High-yield bonds

Category — Bond Types
Bonds with a credit rating of below investment-grade (below BBB- by S&P and Fitch or Baa3 by Moody’s). High-yield bonds offer a high coupon rate at high risk. High-yield bonds are also called junk bonds.

Two groups of issuers of high-yield bonds are identified:
• "Fallen Angels" are companies with a rating that has been downgraded to speculative, usually due to deteriorated financial position;
• "Rising Stars" are companies with initially speculative rating, generally startup companies with no history in the debt market and with the potential to grow to investment level.

The high-yield bond market boom took place in the late 70’s in the USA as a result of operations of Drexel Burnham Lambert headed by Michael Milken, the "king of junk bonds", who started to actively place bonds of the "rising stars". Prior to that, the market was dominated by the "fallen angels". In the 80s, high-yield bonds were used to finance mergers and acquisitions (M&A) and leveraged buyout (LBO). Placement of junk bonds through Drexel Burnham Lambert launched a global hotel chain MGM Resorts International. Milken’s company also contributed to raising funds for the AMC Entertainment Holdings cinema chain and Danaher, the leader of the R&D field.

The high-yield bond segment is often developed in the countries with limited access to bank lending.

High-yield bonds:
• are more similar to stocks at runtime than investment grade bonds, and high-yield bonds are usually less volatile than stocks;
• are more sensitive to credit risk than interest rate risk;
• have a relatively small duration: issues often have a built-in call option and are prematurely repaid in 4-5 years with a maturity of up to 10 years;
• have a statistically low correlation with government bonds and investment grade bonds, thus facilitating portfolio diversification;
• have a high potential to improve the issuer’s performance to the investment level and subsequent price growth, but also a high default risk.

Due to the high default risk, private investors are advised to give preference to certain High Yield Bond ETFs (like iShares iBoxx $ High Yield Corporate Bond ETF). The total risk of investing in high-yield bonds is then reduced as a result of diversification.

Other instruments which are similar to high-yield bonds include common and preference shares with high dividends, convertible bonds, certain types of warrants, and loans to companies with high debt (leveraged loans).

Among the examples of "rising stars" are Tesla, an electric vehicle manufacturer, Netflix streaming service, and Uber Technologies, a mobile application developer for ordering cabs.

The famous "fallen angels" include, for example, Ford, a car manufacturer, Kraft Heinz Foods, a food group corporation, Xerox, an office equipment manufacturer, Occidental Petroleum, a petroleum company, Nokia, a Finnish manufacturer of telecommunications equipment, ArcelorMittal, a Luxemburg iron and steel company, and Teva Pharmaceutical Industries, an Israeli pharmaceutical company.
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