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Junk Bonds

The American Heritage Dictionary defines junk as “something to be discarded or cheap.” Believe it! High yielding securities are called junk bonds for a reason. My biggest concern is that investors are chasing yields, possibly at the expense of principal repayments. Choosing yield over principal repayment is the worst investment decision one can make. Going back to your broker after a bond defaults is meaningless. It just opens a conversation sounding something like this: “You must have known the risk before buying. You signed off on it! I told you not to buy it! Why did you buy it?  They’re called junk bonds for a reason! You just made a bad investment.  Sorry, I have to go. Bye!”

A junk bond is a debenture, where the issuer may or may not have the “financial wherewithal” to repay the principal and interest on the note when due. High yielding securities are bonds or notes with below investment grade ratings. Ratings of Ba by Moody’s or BB by Standard and Poor’s are considered junk bonds. Most new bonds that are sold are non-investment grade securities. Moody’s defines a Ba rating as follows:

Nowadays, many bonds are created as junk bonds. Prior to the 1980’s, however, most bonds started out as investment grade securities. If their financial performance deteriorated to a speculative rating, they were called “fallen angels”; if the company’s ability to repay their debt improved, they were called “rising stars.”  In the late 1980’s the investment firms, led by Drexel-Burnham, used public junk bonds as a funding vehicle for acquisitions. Once the public bought into the idea, it became less expensive to issue public junk bonds than to issue private debt (presumably because there was greater liquidity). Junk bonds remain an acceptable way of investing, until one loses his or her money!

Covenant-Lite Debt: High yielding, leverage loans issued without protective maintenance tests. Debt covenants are there to protect the debt holders; allowing them to call a loan, thus protect their principal, if the financial health of the underlying company declines. Purchasing fixed income securities, without default protection, may result in larger losses, than necessary, if defaults occur.

High yielding debt securities have many of the same trading characteristics as stocks. Money managers with fiduciary responsibility to invest funds have limited ability to purchase these securities.  

Junk bonds are the real estate equivalent of buying urban distressed properties.

 

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