Junk Bond Finance

Junk bond finance substitutes high yield debt for equity.
Bearer Bonds With Numbered Interest Coupons. Stockbyte/Getty Images

Definition: Junk bond finance is a phrase that gained currency in the 1980s, referring to the issuance of high yield bonds to supply funding for small, unseasoned companies or to raise the capital to support corporate takeover bids, including leveraged buyouts.

Prior to that time, so-called junk bonds (also known as high yield bonds) were almost exclusively the debt of seasoned companies that had fallen upon hard times and lost investment grade ratings from the leading rating agencies.

Michael Milken of the once high flying, but now long defunct, investment banking firm Drexel Burnham Lambert is largely acknowledged to be the principal developer of junk bond finance. Milken initially pointed to academic studies indicating that the interest rate premium offered by traditional junk bonds over investment grade bonds was excessive relative to their incidence of default. Thus, Milken began by promoting junk bonds to investors as offering a better tradeoff between risk and return than most investment grade debt.

Later, Milken began promoting junk bonds as a financing vehicle for small and unseasoned companies that typically were unable to raise equity capital.

Finally, during the corporate takeover and leveraged buyout wave in the 1980s, Milken started structuring junk bond offerings to raise the funds needed by corporate raiders.

In 1989, Milken pled guilty to six felony counts related to insider trading schemes involving corporate raider Ivan Boesky.

Both men would pay huge fines suffer imprisonment. Drexel Burnham Lambert would file for Chapter 11 bankruptcy in 1990, and go out of business.

Also Known As: High Yield Finance

Examples: Junk bond finance, as initially conceived, gave small and unseasoned companies access to the capital markets that they lacked previously.

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