Junk Bonds

Junk Bonds

How a CEO can increase his firm's stock price -- overnight!

How junk bonds can be even less risky than US Treasury bonds

Why you should consider investing some money in junk bonds

A drawback to investing in junk bonds

How a CEO can increase his firm's stock price -- overnight!

Up to a point, the cost of debt is lower than the cost of equity

If a stable company like a consumer goods company has no debt, the stock holders can be enriched by replacing stock with tax-deductible debt

Use the newly issued debt to buy back shares

Company still has the same earning power, but now more cash is given to bond and stock holders rather than the US Treasury

Tax Reform Act of 1986 removed other corporate tax shelters, so debt became about the last remaining way to shelter income

This was a big factor in the junk bond craze of the late 1980s

Having some debt increases risk and return for stock holders

Now bond holders try even harder to prevent CEOs from taking on too much debt

Insert "poison puts" and other clauses into bond contract

How junk bonds can be even less risky than US Treasury bonds

Most junk bonds have maturities of 10 years or less

The interest rate risk faced by these intermediate-term junk bonds is less than that for 30 year US Treasury bonds

Why you should consider investing some money into junk bonds

Because many institutions like commercial banks and some pension funds can not invest in junk bonds, you can probably earn a little extra money by investing in junk bonds

Junk now comprises about 25 percent of corporate bond market

But don't invest more than 20 percent of your bond money in junk bonds

Junk acts as a hybrid security

Mixture of bond and stock aspects

Won't zig and zag the same way as your straight bond or stock investments

But don't be fooled by high yields on junk bonds

For the most part, what you gain in extra yield you surrender in principal losses

A drawback to investing in junk bonds

Junk bonds make large taxable interest payments

Many junk bonds are zero-coupon bonds

Present a cash flow problem to investors in taxable accounts

Tax is due on interest payments, but zero-coupon bonds don't provide cash to pay off tax

Try to shelter these taxable interest payments by placing your junk bonds into retirement accounts