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Understanding Corporate Bonds: Types, Ratings, and Market Dynamics

Explore corporate bond types, ratings, market behavior, and investment implications. Learn about high-yield bonds, leverage buy-outs, bond features like call and put options, and secondary market dynamics. Delve into bankruptcy rules and financial engineering.

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Understanding Corporate Bonds: Types, Ratings, and Market Dynamics

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  1. Chapter 21 – Corporate Debt II • Typical or Standard Bond • Interest paid as you go • Principal paid at maturity date • Yield determined by the market which views • Default Potential (Risk of Bond) • Inflation (Real Rate Necessary) • Bond Features (Call Options, Collateral, etc.) • Ratings by Agencies help assess the information for market yields • Table 21-1

  2. Chapter 21 – Corporate Debt II • What do the ratings mean? • Investment Grade BBB and above • Distinctly Speculative B to BB • Predominately Speculative Below B • “junk bonds” • “high-yield bonds” • Bonds in Default, D • Have missed payment on interest • Bond Trustee “filed” on missed payment • Fallen Angels

  3. Chapter 21 – Corporate Debt II • A Look at the High-Yield Bonds • Participants (Investment Bankers) • Drexel, Burnham, & Lambert (Michael Milken) • Merrill Lynch, Morgan Stanely, and First Boston • Firms • John Kluge and Metromedia – 1984 • Kolberg, Kravis, Roberts & Co. and Beatrice – 1986 • A new market for attracting capital (replacing bank loans)

  4. Chapter 21 – Corporate Debt II • Leverage Buy-Out (LBO) • Using a firms own borrowing capacity to pay for outside management team’s purchase of firm • Uses • Deferred Interest Bonds • Step-up Bonds • Payment-in-kind Bonds • Management Buy-Out (MBO)

  5. Chapter 21 – Corporate Debt II • Bond Features • Call Option – right of the company to buy back the bond for a pre set price • Put Option – right of the bondholder to sell back the bond for a pre set price • Conversion feature – right of the bondholder to convert the bond into equity shares • Warrants Attached – an additional financial asset that grants the right to buy equity • Zero-Coupon Bond – pure discount bond • Floating Rate Bond – coupon rate changes

  6. Chapter 21 – Corporate Debt II • Secondary Market for Bonds • Exchange Market (NYSE) – small volume • OTC • Market used by institutional investors and professional money managers • Brokers search Dealers (Dealer Market) • Trading Desks – Bond Pits in investment banks • The Technology Changes • Moving to Web Sites that have prices • Remove the extended search process

  7. Chapter 21 – Corporate Debt II • Other Information • Eurobonds • Issued outside of country of company • Many different features • Preferred Stock • Dividends preferred (guaranteed?) • Convertible to Common in some cases • Adjustable rate (floating rate) • Financial Engineering of bonds and preferred stock to meet the market demands

  8. Chapter 21 – Corporate Debt II • Bankruptcy • The Bankruptcy Reform Act of 1978 • Rules for liquidation or reorganization • Safe Harbor – Time to Think • Chapter 7 – Liquidation • Company sells off remaining assets • Pays creditors on a priority basis • Chapter 11 – Reorganization • Plan approved by Court • Plan approved by Claimants via Class

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