Accidental High Yielder

  

The bond was originally offered at par of $1,000 with a coupon of 3.2%. It was supposed to be rock-solid safe. It was owned by nervous nellies and insurance companies and foreign governments as a store of wealth...all playing defense, not offense.

But then bad things happened to the bank who issued those bonds. Bad trades, fraud, and that whole ignoring-of-the-internet thing. So the creditworthiness behind the bond plummeted, and it now trades for $300, still with that same $32 a year coupon. Only now, the bond is a high yielder..."accidentally"...and yields over 10%.

The same can happen to dividend-paying equities. All is grand and safe and secure and gravy...until it's not.

Related or Semi-related Video

Finance: What are High Yield/Junk Bonds?19 Views

00:00

finance a la shmoop. what are high-yield or junk bonds? alright well here are low

00:08

yield bonds, you know Apple Microsoft you know, safe secure sleep [charts]

00:12

like a baby even for Chicken Little those kind of bonds. the sky is not

00:17

falling. all right well here are high-yield bonds Sears you know Toys R

00:20

Us aren't they bankrupt already best buy well someday bankrupt ,yeah not safe not

00:25

secure, the sky among other things like credit ratings is in fact falling. well [definitions on screen]

00:32

why do high-yield bonds yield a lot that is they pay a lot of interest to

00:36

investors why do they do that answer because they have to. right but

00:40

why why do they have to? well because the bonds are risky either the business is

00:45

in danger of dying, or the business has borrowed so much money that it's in [ best buy pictured]

00:50

danger of not being able to pay back the loans. that is their operating profit is

00:54

just barely enough to pay the interest costs on all the loans they've borrowed

00:59

so the risk of default is high and investors demand very high interest for

01:04

taking on the risk of having to go through a potential bankruptcy. the term

01:08

junk was coined in the 1980s when the now-defunct investment bank Drexel [100 dollar bill]

01:13

Burnham Lambert sold boatloads of bonds which had dubious creditworthiness in

01:17

weak backing and so the boatloads of bonds sank and ended up as basically

01:23

junk. and not the Chinese junk that actually sales, a different kind of junk.

01:27

anyway unlike your fancy triple-a bonds which you can see here on this lovely [ boat sails on a lake]

01:31

table ,those junk bonds were riskier than us women in shark-infested waters with a

01:36

bloody nose. so what's the best way to encourage people to do risky possibly

01:40

dangerous things ?well pay them a lot of money. so that's why junk bonds yield

01:45

such killer returns for investors because otherwise well these things [two people frown in front of bond store]

01:49

would never leave the shelf.

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