High-yield debt

An instrument of high yield debt issued by a corporation or governmental agency is commonly known as a "Junk bond."

In modern economies, debt is bought and sold in the form of bonds traded in organized markets. The price of a bond is determined by numerous factors, including the interest rate, the term, and the degree of risk associated with the underlying assets. The risk of a bond is determined by one of serveral credit rating agencies such as Standard & Poors and is expressed by a rating such as 'AAA' (where 'A' is better than 'B' and 'AA' is better than 'A').

For a bond to be considered 'Junk' it must have a rating lower than a certain level. This lower rating implies a higher yield, making junk bonds attractive investment vehicles for certain types of financial portfolios and strategies. Many pension funds and other investors, however, are prohibited in their by-laws from investing in bonds which have ratings below a particular level.

Junk bonds were popularized in the 1980s by Michael Milken as a financing mechanism primarily for mergers and acquisitions. In a leveraged buyout or LBO an acquirer would issue junk bonds to pay for a corporate acquisition and then use the cash flow of the target company to pay off the debt over time. This strategy was widely used in the '80s, with both success and dramatic failure. A very well-known LBO was the purchase of Nabisco by Kohlberg, Kravis, and Roberts (KKR) as chronicled in the book Barbarians at the Gate.

Since many LBOs resulted in corporate bankruptcy, their use as a financing tool declined during the 1990s. However, junk bonds are still used to finance capital intensive industries such as telecommunications.