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principles of finance a la shmoop... rocky road high-yield or junk bonds

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high-yield bonds aren't really a type category unto themselves that is a bond [High yield bond description]

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that has a high-yield today could have started out as a really safe low

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yield bond a while ago and then the company backing it stumbled they put out

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bad product they didn't pay attention to competition they just stunk one way or

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another and I think Sears or Toys R Us well let's say you had a bond that was [Toys R Us store]

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issued with a 5% coupon at par or a hundred cents on the dollar or a

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thousand dollars as being the price paid to get 50 bucks a year paid each year

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for 15 years until that bond was paid off but then all the sudden the specter

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of the b-word you know bankruptcy came along and the credit worthiness of the [Ghost appears in a corridor]

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bond suddenly came into question as the company was just barely able to make its

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interest payments last quarter....well, nervous nellie bond investors desperate

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to get out from a messy illiquid bad returned bond situation actively dumped

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units of the bonds which started out in a thousand bucks and declined [Bond declining face value]

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precipitously to finish the first weeks trading selling for only 500 bucks while

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the coupons remained 5% only now investors paying $500 for that stream of

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50 dollars a year for the remaining years on the bonds duration were

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getting a 10% yield instead of a 5% yield...In the scheme of things these days

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that's very high yield also known as yes junk bonds while high-yield bonds gained

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fame and infamy as junk in the 1980s when they were used as openly highly [Woman answers telephone]

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risky vehicles to make acquisitions in real estate, Midwestern factory produced

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stuff and a bunch of other edgy targets for example, yeah Michael

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Millikin... prominent financier ended up going to [Michael Millikin behind bars]

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prison for having "falsely marketed the quote junk bonds" and

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well, that era is long gone but bonds that have high-yield are here to stay so

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what are the specifics that make a bond high-yield well usually risk if a

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company has a hundred million dollars in operating profits pre-tax and has a

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billion dollars of debt which cost the company 80 million dollars a year just

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to pay the interest meanings 8% bonds well it's likely that the billion bucks

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of debt carries a very high yield wait how does that work? well, the company

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probably had at one point two hundred million dollars in operating profits and

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they raised a billion dollars with an 8% coupon thinking that they'd quickly pay [Company example of operating profit]

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down the principal such that after year one the two hundred million dollars less

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eighty million dollars of interest would make their billion bucks of debt stand

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at eight hundred eighty million and if they did the same for two to three more

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years well they'd be at a very easily digestible leverage ratio and all would [Person gives a thumbs up]

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be just fine but then something bad happened the market changed the new

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Barbie product was laced in arsenic instead of silk trade treaties killed

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the foreign marketplace whatever so instead of having projected operating [The Queen and Trump talking]

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profits of two hundred million, two hundred fifty million and three hundred

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million the company had two hundred million one hundred million and oof yeah

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that is if the management had projected plan a to Wall Street and been oh, so

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wrong well why would the street trust them now guess what they wouldn't and so

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it's likely that the common equity of a company with this kind of stumble is [Person removes stock]

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trading it pennies a share the "smart money" is betting that the company

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goes bankrupt but here's where real investors can make real money if you

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look at the new release of product from the company and it actually clicks and [Man checking companies on computer]

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you see evidence from the Amazon trending data that people are actually

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starting to buy it well then all of a sudden you wonder if the company wasn't

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fully wrong in their leveraging maybe they were just early if the company was

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teetering on the edge of bankruptcy with bonds with a coupon of eight percent now

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trading at 50 cents on the dollar to give a very high yield of 16 percent

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would you want to buy the bonds here if you believe the new products are really

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gonna work well if you only could buy bonds then probably odds are good that

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16 percent is money good in 16% that's great return for a bond so maybe you're [Person giving thumbs up]

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really smart and good and lucky and you have really good returns more than

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doubling your money and then some as the bonds go back to par and have a yield of

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8% you know trading from 50 cents on the dollar to a hundred cents on the dollar

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and maybe the company pays off the debt and you do slightly better than doubling

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your money or at least doubling your yield that is so you do way better than

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doubling your money it's nice-ish...but if you had a

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thrill for the edge and you were smart and you were good and you had enormous [Man holding a bowling ball]

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cojones that say Brunswick on em, well you'd probably buy the stock here the

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common equity trading at seventy three cents a share what was likely trading in

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the 20 or $30 a share range just a year or two ago and if the company returns to

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anything close to parity with its old self instead of doubling your money and

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change in the bond land you'd make like 30 times your money and more in the

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equity land why are we focusing on equity and a discussion of high-yield

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bonds here well because often high-yield bonds trade like or are highly

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correlated with how the equity is performing and a lot of money is left on [Money appears on the table]

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the table by being "too safe" and buying bonds when investors should have

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just bought the stock...High-yield bonds are risky in a lot of ways in which

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equities are risky but their upside is capped at most you just get your

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principal back with all the back interest equities are uncapped they can

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go really high anyway high-yield bonds generally live in the [High-yield bond with professional investor]

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domain of professional investor to have access to company management and all

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kinds of data not available to a joke consumer investor, at least not easily

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so if you're buying junk be sure you're okay you know with the smell [Man with a junk bond walking through landfill]

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