Leveraged Finance Ch 2: High Yield Bond Market

Question 1

Describe three main types of companies that are high yield bond issuers

Answer 1

New start-up companies that have high growth prospects, but lack the stronger
balance sheet and better income statement profile of more established
corporations

Fallen angels are companies that formerly had investment-grade-rated debt, but
now have deteriorating balance sheets and weakening coverage metrics

Companies involved in shareholder-friendly activity that deliberately increase their
debt burden with a view toward maximizing shareholder value

Question 2

Describe a few different structures of high yields bonds that are different from the
conventional bond structure that pays a fixed coupon rate and the par value at maturity

Answer 2

Deferred-interest bonds: A type of cash hoarding coupon structure; sells at a
deep discount in the primary market and does not pay interest for an initial period
(typically 3 to 7 years)

Step-up bonds: The coupon rate is low for an initial period, but then increases
later to a higher coupon rate
Ÿ The coupon step up can be triggered by factors such as a ratings downgrade

Payment-in-kind (PIK) bonds: Give the issuer an option to pay coupons with
additional bonds (with same coupon rate and par value as the original bond)
rather than cash
Ÿ Many companies that have issued PIKs decided to pay coupons in kind in order to
conserve liquidity (preserve the cash they had for other purposes)

Question 3

Describe three key properties of credit rating transitions for high-yield bonds

Answer 3

Down more likely than up: High-yield companies are more likely to go down the
ratings spectrum than up

Small moves are fairly balanced: The migration up or down one rating notch by an
issuer is fairly balanced

Tail risk is decidedly negative: Much more likely for the high-yield bond to go into
default the next year than to have a dramatic positive ratings upgrade to a level
like Aaa