A Primer on High-Yield Bonds
April 8, 2009 by How Savings Bonds Work
Filed under High Yield Investing
As its name suggests, a high-yield bond (also known as a junk bond) is a bond that offers high yields in exchange for a higher risk of defaulting (i.e. a greater returns from interest rather than principal).
In the U.S., there are three principal credit rating agencies: S&P, Moody’s, and Fitch Ratings. These companies rate bonds according to the probability of default together with the probability of not receiving interest and principal subsequent to a default (i.e. credit risk).
For example the scale used by S&P and Fitch is: AAA, AA, A, BBB, BB, B, CCC, CC, C, and D (sometimes consisting of sub-categories). Bonds that are rated AAA by S&P are considered “prime, maximum safety”, and most government bonds fall into this category.
A credit rating BBB or higher indicates that the bond is investment grade, while a credit rating lower than BBB indicates that the bond is non-investment grade, or junk (hence the alternative title of high-yield bonds).
Some institutional investors (e.g. pension funds) are prohibited from investing in bonds below a particular grade level.
For companies whose bonds have been rated investment grade, a downgrade to “junk” status can be a difficult situation. Not only will newly issued bonds now require significantly higher interest payments, but the relatively narrow market for junk bond issues can make them higher to sell. A bond with a credit rating that has dropped below investment grade is commonly referred to as a “fallen angel”.
High-yield bonds play an important role in some investment strategies. A common strategy involving high-yield bonds is merger arbitrage. In a merger, an acquirer would issue junk bonds to help finance an acquisition, after which the acquirer would use the acquired target’s cash flow to pay the debt over a period of time.
For many industries, junk bonds are an important source of capital.
Some recommended reading: Beyond Junk Bonds by Glenn Yago and Susan Trimbath. This book is a very comprehensive guide to the high-yield market in general. Includes case studies of actual firms and securities in the industry, as well as comparisons to the private/public equity, and fixed income markets.
Another highly recommended title, written by an authority on distressed debt and bankruptcy, is: Bankruptcy, Credit Risk, and High Yield Junk Bonds by Edward I. Altman. Includes a dedicated section to High Yield “Junk Bonds and Distressed Securities, and articles from other scholarly contributors around the world.
Thanks to Gary Spitz for contributing this article to our Bonds blog:
In the U.S., there are three principal credit rating agencies: S&P, Moody’s, and Fitch Ratings. These companies rate bonds according to the probability of default together with the probability of not receiving interest and principal subsequent to a default (i.e. credit risk).
For example the scale used by S&P and Fitch is: AAA, AA, A, BBB, BB, B, CCC, CC, C, and D (sometimes consisting of sub-categories). Bonds that are rated AAA by S&P are considered “prime, maximum safety”, and most government bonds fall into this category.
A credit rating BBB or higher indicates that the bond is investment grade, while a credit rating lower than BBB indicates that the bond is non-investment grade, or junk (hence the alternative title of high-yield bonds).
Some institutional investors (e.g. pension funds) are prohibited from investing in bonds below a particular grade level.
For companies whose bonds have been rated investment grade, a downgrade to “junk” status can be a difficult situation. Not only will newly issued bonds now require significantly higher interest payments, but the relatively narrow market for junk bond issues can make them higher to sell. A bond with a credit rating that has dropped below investment grade is commonly referred to as a “fallen angel”.
High-yield bonds play an important role in some investment strategies. A common strategy involving high-yield bonds is merger arbitrage. In a merger, an acquirer would issue junk bonds to help finance an acquisition, after which the acquirer would use the acquired target’s cash flow to pay the debt over a period of time.
For many industries, junk bonds are an important source of capital.
Some recommended reading: Beyond Junk Bonds by Glenn Yago and Susan Trimbath. This book is a very comprehensive guide to the high-yield market in general. Includes case studies of actual firms and securities in the industry, as well as comparisons to the private/public equity, and fixed income markets.
Another highly recommended title, written by an authority on distressed debt and bankruptcy, is: Bankruptcy, Credit Risk, and High Yield Junk Bonds by Edward I. Altman. Includes a dedicated section to High Yield “Junk Bonds and Distressed Securities, and articles from other scholarly contributors around the world.
Thanks to Gary Spitz for contributing this article to our Bonds blog:
Gary Spitz is a principal of Mt. Rushmore Securities LLC, a broker-dealer registered with the SEC and a member of the NASD which provides brokerage services to private investment pools or funds for compensation. He authors the Hedge Fund Consistency Index
Bonds Credit Rating/rating of Bonds
March 17, 2009 by How Savings Bonds Work
Filed under About Bonds
risk of default involved with corporate bonds. So how does an investor decide on which companies’ issues he has to invest in? The market participants can’t assess the risk involved as they may not have full information about corporates. They rely on credit rating agencies before taking an investment decision. These credit rating agencies give ratings to corporate issues by applying proprietary methodologies for assessing financial strength of the issuers and risks that may impair their capability to payback interest as well as principal.
There are a number of ratings service organizations that provide a breakdown of relevant factors that can impact the bond rating process. After evaluating each factor that is involved in arriving at the bond rating, the agencies provide a consolidated rating. Ratings provided by Moody’s Investors Service and Standard & Poor (S&P) are very famous in US. The other rating agencies are Fitch, Pacific Credit Rating, Egan-Jones Ratings Company. In India ICRA (Investment information and Credit Rating Agency) and CRISIL (Credit Rating Information Services of India Limited) are leading credit rating agencies. ICRA is an associate of Moody’s Investors Service.
A point to be noted here is the credit rating is specific to the issue and not issuer specific. This is because a medium scale company which got Baa rating for it’s previous issue may not get the same rating if it comes up with a new big issue. More over the credit rating agencies consider re-rating the previous issue.
In addition to the ratings listed above, Moody’s adds a “1″ to indicate a slightly higher credit quality. For example, a rating of “A1″ is slightly higher than a rating of “A” whereas “A3″ is slightly lower. S&P ratings may be modified by the addition of a “+” or “-”. “A+” being slightly higher grade than “A” and “A-” being slightly lower.
Occasionally you may see some bonds with an “NR” in either Moody’s or S&P. This means Not Rated and does not necessarily mean that the bonds are of low quality. It basically means that the issuer did not apply to either Moody’s or S&P for a rating. Government agencies are a good example of very high quality bonds that are not rated by Standard and Poors (S&P).
Thanks to Emmadi for contributing this article to our Bonds blog:
There are a number of ratings service organizations that provide a breakdown of relevant factors that can impact the bond rating process. After evaluating each factor that is involved in arriving at the bond rating, the agencies provide a consolidated rating. Ratings provided by Moody’s Investors Service and Standard & Poor (S&P) are very famous in US. The other rating agencies are Fitch, Pacific Credit Rating, Egan-Jones Ratings Company. In India ICRA (Investment information and Credit Rating Agency) and CRISIL (Credit Rating Information Services of India Limited) are leading credit rating agencies. ICRA is an associate of Moody’s Investors Service.
A point to be noted here is the credit rating is specific to the issue and not issuer specific. This is because a medium scale company which got Baa rating for it’s previous issue may not get the same rating if it comes up with a new big issue. More over the credit rating agencies consider re-rating the previous issue.
In addition to the ratings listed above, Moody’s adds a “1″ to indicate a slightly higher credit quality. For example, a rating of “A1″ is slightly higher than a rating of “A” whereas “A3″ is slightly lower. S&P ratings may be modified by the addition of a “+” or “-”. “A+” being slightly higher grade than “A” and “A-” being slightly lower.
Occasionally you may see some bonds with an “NR” in either Moody’s or S&P. This means Not Rated and does not necessarily mean that the bonds are of low quality. It basically means that the issuer did not apply to either Moody’s or S&P for a rating. Government agencies are a good example of very high quality bonds that are not rated by Standard and Poors (S&P).
Thanks to Emmadi for contributing this article to our Bonds blog:
Emmadi from www.lastbull.com
