Business Finance - Junk Bonds

PART3

3.6 Junk Bonds

Junk bond are the bonds that pay high yield with high default risk and are typically rated 'BB' or lower by Moody’s/Standard & Poor’s.

Low-grade bonds issued by company with a low-priority claim in bankruptcy, or with the risk of unable to meet their debt obligations. As most investors do not invest in these low-grade bonds, they are known as junk bonds.

Junk bonds still keep some values due to it pays high yield. The lower the credit rating of the bond, the higher the return investors will get after issuer breached the contract.

Morningstar, 2015, What Are Junk Bonds? Retrieved April 19 , 2015.

http://news.morningstar.com/classroom2/course.asp?docId=5401&page=2

3.5 Rating bonds

Rating agencies provided the rating information of bonds’ creditworthiness to investors that encourage widespread investor participation. By serving as information intermediaries in the capital market, rating agencies increase the potential borrowers by reduce the information costs, and therefore to promote the liquid market.

The rating process of a rating agency is start from the

3.1 Price of AA-rated bond

To determine the price of AA-rated bond, firstly to calculate the coupon payment for each year which is $65. Then due to the yield to maturity for a coupon bond is the discount rate. Hence, according to bond price formula we conduct the price of AA-rated bond is $1008.36.

Formula

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3.2 Principle amount of bond to be issued

Each AA rated bond will raise $1008.36 so the KLM have to issue 9918 bonds ($10millions/$1008.36). Therefore, the correspond principle amount of bond issued by KLM is the total bond issued * the face value of each bond which is $991800 (9918*$1000).