CONTENTS
PART ONE MARKET STRUCTURE
1 The High Yield Market = 3
2 Changes in the High Yield Market : A Historic Perspective = 17
3 The Leveraged Loan Market = 40
4 The Globalization of the High Yield Market = 61
PART TWO SECURITY RISK ANALYSIS
5 Historical Default Rates of Corporate Bond Issuers, 1920-1996 = 75
6 Almost Everything You Wanted to Know about Recoveries on Defaulted Bonds = 104
7 Moody's Rating Migration and Credit Quality, Correlation, 1920-1996 = 118
8 Modeling Bond Rating Changes Oar Credit Risk Estimation = 156
9 Real Interest Rates and the Default Rate on High Yield Bonds = 164
PART THREE SECURITY VALUATION
10 Valuing Like-Rated Senior and Subordinated Debt = 177
11 Determinants of Spreads on New High Yield Bond Offerings = 198
12 Analyzing a High Yield Issue = 220
13 Valuing Bonds and Options on Bonds Having Correlated Interest Rate and Credit Risk = 232
PART FOUR MARKET VALUATION MODELS
14 Monetary Influences on the High Yield Spread versus Treasuries = 251
15 Modeling the Yields on Noninvestment-Grade Bonds = 209
16 The January Effect in the Corporate Bond Market : A Systematic Examination = 280
PART FIVE PORTFOLIO MANAGEMENT
17 High Yield as an Asset Class = 305
18 An Analysis of High Yield Bond Indices = 336
19 How Many High Yield Bonds Make a Diversified Portfolio? = 370
20 Managing a High Yield Portfolio = 380
21 Monitoring a High Yield Portfolio = 391
22 Modeling High Yield Bond Portfolios with Correlated Interest Rate and Credit Risk = 401
PART SIX INVESTING IN DISTRESSED SECURITIES
23 Do Seniority Provisions Protect Bondholders' Investments? = 415
24 Investing in Distressed Situations : A Market Survey = 431
25 Analyzing the Credit Risk of Distressed Securities = 473
PART SEVEN CORPORATE FINANCE
26 Strategic Financing Choices for Emerging Firms : Debt versus Equity = 489
27 The Advantages and Disadvantages of Public versus Private Issuances of High Yield Debt Securities = 507
28 Managing Default : Some Evidence on How Firms Choose between Workouts and Chapter 11 = 546
PART ONE MARKET STRUCTURE
Chapter 1 The High Yield Market = 3
Introduction = 3
The Early to Mid-1980s = 4
The Growth of Acquisition Financing = 5
Some Structural Developments = 6
LBO Returns = 7
Other Developments of Note = 8
The Rating Agencies versus the Market = 9
Peak Default and Redemption = 10
New Issuing Trends in the 1990s = 11
Other Structural Developments = 12
New Analysis Tools = 13
Closing Comments = 13
Summary of Typical High Yield Bond Covenants = 15
Chapter 2 Changes in the High Yield Market : A Historic Perspective = 17
Introduction = 17
Evolution of the Market : High Yield Leveraged Loans, Infancy. and Private Placement = 18
Phase Ⅰ = 19
Phase Ⅱ = 20
Phase Ⅲ = 20
The Major Shifts = 22
Information Overload／Management Challenge = 22
The Sector Exposure to a Footprint Argument = 22
Management Fee Compression = 23
The Inflation／Growth Shift = 23
Rapid Increase in Risk of the Secondary Market in 1980s Relative to Decline in Risk in the 1990s = 26
The Proliferation of High Yield Portfolio Management Styles = 28
The Role of Derivatives／Structured Products : A Risk Reward Spectrum = 28
The Improvement in the Average Credit Statistics by Rating = 28
The Shift in Capitalizing Cyclical Credits = 30
Event Risk : A Shift from the Role of Equity Issuance to M&A Transactions = 31
Dramatic Shift in Seniority = 37
The Increased Importance of Diversification in a Global Linked Markets Environment = 38
The United States versus the Global Bet Shift = 39
Chapter 3 The Leveraged Loan Market = 40
Background = 40
Leveraged Loan Risk／Return Profile = 42
Leveraged Loan Products and Market Segments = 43
Pricing : Spreads and Fees = 45
Structure and Covenants = 48
Recent Trends = 49
Pricing = 50
Credit Statistics = 52
Appendix 1 Syndicated Leveraged Loan Characteristics = 57
Appendix 2 Secondary Loan Sales and Trading = 59
Chapter 4 The Globalization of the High Yield Market = 61
PART TWO SECURITY RISK ANALYSIS
Chapter 5 Historical Default Rates of Corporate Bond Issuers, 1920-1996 = 75
Introduction = 75
1996 Default Overview = 76
Ratings and Default Data = 77
Defaults and Default Rates = 80
Definitions and Methodology = 80
Defaults Since 1920 = 81
One-Year Default Rates = 83
Multiyear Default Rates = 86
Comparison with Hickman's (1958) Default Rates = 88
Default Rate Volatility = 89
Recovery Rates = 90
Defaulted Bond Price Volatility = 94
Loss Rates = 94
Conclusion = 95
Appendix = 97
Chapter 6 Almost Everything You Wanted to Know about Recoveries on Defaulted Bonds = 104
Introduction = 104
Recovery Rates by Seniority = 106
Recovery Rates by Industry = 106
Recovery Rates by Seniority within Industries = 111
Testing for Statistical Significance = 114
Recovery Rates by Seniority and Original Credit Rating = 115
Conclusion = 116
References = 116
Chapter 7 Moody's Rating Migration and Credit Quality Correlation, 1920-1996 = 118
Introduction = 118
Data and Methodology = 119
Rating Migration = 122
Trends in Corporate Credit Quality from 1920 through 1996 = 122
Rating Change Magnitude = 123
Rating Change Magnitude and Direction - Rating Transition Matrices = 124
Withdrawn Ratings = 127
Multiyear Rating Transition Matrices = 130
Rating Transition Rate Volatility and Credit Quality Correlation = 131
Rating Transition Rate Volatility = 131
Credit Quality Correlation = 133
The Impact of Credit Quality Correlation = 137
Industrial and Geographic Considerations for Credit Quality Correlations = 139
Conclusion = 142
Appendix = 143
Chapter 8 Modeling Bond Rating Changes for Credit Risk Estimation = 156
Introduction = 156
Historical Transition Matrices = 157
Credit Rating Simulation = 157
Simulating Equity Returns and Debt to Value Ratios = 158
Mapping Debt Ratios into Bond Rating Categories = 160
Credit Transition Matrices = 160
Comparison of Historical and Simulated Transition Matrices = 161
Simulating Correlated Changes in the Credit Rating for a Portfolio of Bonds = 162
Conclusion = 162
References = 163
Chapter 9 Real Interest Rates and the Default Rate on High Yield Bonds = 164
Motivation for Research on Default Rates = 164
Literature Overview = 165
The Curious Absence of Interest Rates = 166
Measuring Correlations = 167
Modeling Default Rates with a Real Interest Rate Variable = 170
Conclusion = 173
Reference = 173
PART THREE SECURITY VALUATION
Chapter 10 Valuing Like-Rated Senior and Subordinated Debt = 177
Introduction = 177
The Trade-off between Default Probability and Expected Recovery = 178
Evidence from the Primary Market = 183
Evidence from the Secondary Market = 185
How Does the Market Get It Right? = 191
Conclusion = 193
Appendix 1OA Notching Policies for Senior and Subordinated Ratings = 95
Appendix 10B Structural Subordination = 197
References = 197
Chapter 11 Determinants of Spreads on New High Yield Bond Offerings
Introduction = 198
Methodology = 199
Company-Specific Variables = 200
Rating = 200
Seniority = 203
Term = 203
Callability = 204
Zero Coupon Status = 205
Float = 205
144a Status = 206
First-Time Issuer = 206
Underwriter Type = 207
Environmental Variables = 207
Spread versus Treasuries = 207
BB／B Spread = 207
Yield Curve = 208
Default Rate = 208
IPO Volume = 208
Forward Calendar = 209
Mutual Fund Flows = 209
Mutual Funds Cash Position = 210
Interest Rate Change = 210
High Yield Return = 210
Correlation Results = 210
Creating a Multiple Regression Model = 212
Testing for Period Dependence = 214
Possible Sources of Unexplained Variance = 214
Issuer's Industry Category = 216
Quality of Management Presentation = 217
Conclusion = 217
References = 218
Chapter 12 Analyzing a High Yield Issue = 220
Introduction = 220
Industry Analysis = 221
Financial Analysis = 222
1. Analysis of Cash Flow Generation = 222
2. The Ability to Deleverage = 222
3. Amortization Schedules = 223
4. Quality and Salability of Assets = 223
5. Priority of Debt in the Capital Structure = 223
6. Capital Expenditure Requirements and Company's Life Cycle = 224
7. Event Risk = 224
8. Liquidity = 224
Covenant Review = 225
Limitation on Indebtedness = 225
Restricted Payments = 226
Change of Control = 226
Asset Sales = 226
Senior Management = 227
Track Record and Reputation of Management = 227
Equity Ownership = 227
LBO Sponsors = 228
Corporate Goals and Vision = 228
Style of Management = 228
Trading Factors = 229
Size of Issue = 229
Number of Marketmakers and Wall Street Sponsorship = 229
Duration = 230
Relative Yield Spreads = 230
Conclusion = 231
Chapter 13 Valuing Bonds and Options on Bonds Having Correlated Interest Rate and Credit Risk = 232
Introduction = 232
Credit Event = 233
Stochastic Credit Risk = 233
Recovery Rates in the Event of Default = 234
Utilizing Transition Matrices and Recovery Rates to Value Bonds before Maturity = 234
Term Structure Estimation by Rating Category = 237
Modeling Multiple Stochastic Term Structures = 237
Modeling the Value of the Underlying Bond = 239
Credit Rating Simulation = 240
Calibrating the Model (Arbitrage Tests of Simulations) = 240
The Effect of the Correlation Structure on the Results = 241
The Simulated Credit Risk of Ba-and B-Rated Bonds = 242
Valuing Options With Credit Risk = 242
Conclusion = 245
References = 246
PART FOUR MARKET VALUATION MODELS
Chapter 14 Monetary Influences on the High Yield Spread versus Treasuries = 251
Introduction = 251
Historical Average Spread = 253
Fridson-J o' nsson Model(1995) = 254
Credit Risk = 254
Illiquidity Risk = 255
Motivations for Further Analysis = 255
Monetary Indicators and the Babson Model = 257
Impact of the Ratings Mix = 258
Influence of the General Level of Interest Rates = 262
A New Synthesis : The Garman Model = 263
Default Risk = 263
Illiquidity Risk = 263
Monetary Conditions = 263
Garman Model's Verdict on High Yield Market's Valuation = 265
References = 268
Chapter 15 Modeling the Yields on Noninvestment-Grade Bonds = 269
Introduction = 269
A Long-Run Mean Reverting Relationship between Noninvestment-Grade Yields, Treasury Yields, and Default Rates = 270
Error Correction Models and Short-Run Dynamics = 273
Short Run Dynamic Factors Tested = 273
Estimating Error Correction Models for the Noninvestment-Grade Bond Indic es = 275
Empirical Findings = 277
Segmentation of the High Yield Market = 278
Conclusion = 278
References = 279
Chapter 16 The January Effect in the Corporate Bond Market : A Systematic Examination = 280
Introduction = 280
Seasonal Variation in Corporate Bond Returns and Yields = 281
The January Effect in the Corporate Bond Market = 281
Theories that Explain the January Effect = 282
The January Effect and Bond Ratings = 282
Strength the January Effect = 284
The January Effect in the Corporate Bond Market and Firm Size = 286
Seasonal Buying and Selling Patterns = 287
Noninvestment Grade Bond Supply = 290
Individual Investor Seasonal Demand = 290
Window Dressing = 293
Modeling the Seasonal Component of the BBB, Split BBB, and BB Indices = 294
Cointegration Analysis = 294
Estimating an Error Correction for the Indices = 297
Conclusion = 298
References = 300
PART FIVE PORTFOLIO MANAGEMENT
Chapter 17 High Yield as an Asset Class = 305
Risk／Reward and Its Role in Static and Tactical Asset Allocation = 305
Key Conclusions = 310
Risk and Return = 313
Price versus Return Volatility = 314
Sector Volatility = 315
Correlation／Autocorrelation = 319
Inherent Market Volatility = 322
The Role of Volatility as a Portfolio Management Tool = 322
Twenty-Month Rolling Volatility = 324
The Beta of the High Yield Market = 325
Yield Dispersion and Eight-Month Price Volatility = 328
Interest Rate Effect : Duration Significance in High Yield Portfolios = 328
Equity／Cycle Component = 330
High Yield Correlation with Equity and Treasury Markets = 330
Cycle Rotation = 332
Conclusion = 332
Chapter 18 An Analysis of High Yield Bond Indices = 336
Introduction = 336
Importance of the Benchmarks = 337
Organization of the Chapter = 338
Constructing a High Yield Bond index = 339
Description of High Yield Bond Series = 340
Important Index Characteristics = 340
Index Sample = 340
Return Weights = 341
Bond Pricing = 341
Bond and Stock Market Indexes Analyzed = 342
The Risk-Return Performance : Composite High Yield Indexes = 345
Risk-Return Performance : High Yield Rating Categories = 348
Correlations among Alternative Indexes = 352
Composite High Yield Bond Indexes = 352
High Yield Rating Category Indexes = 353
Index Tracking Deviation Results = 356
Investment-Grade Index Tracking Deviations = 357
High Yield Index Tracking Deviations = 359
High Yield Rating Category Tracking Deviations = 360
Autocorrelations of Tracking Deviations = 361
Time Series Results = 362
Changes in the Characteristics of High Yield Bond Market = 362
Makeup of the HY Bond Market = 362
Changing Duration of the HY Bond Market = 364
Summary and Implication = 365
Summary = 365
Implications = 366
References = 367
Chapter 19 How Many High Yield Bonds Make a Diversified Portfolio? = 370
Introduction = 370
Total Return or Default Experience? = 371
Implementing a Default-Based Approach = 372
Credit Quality's Impact on the Number of Issues Required = 378
Conclusion = 378
References = 379
Chapter 20 Managing a High Yield Portfolio = 380
Introduction = 380
Investment Objectives = 380
Guidelines and Restrictions = 381
Diversification = 382
Investment Philosophy = 383
Technical Factors = 384
New Issue Supply(Forward Calendar) = 384
Mutual Fund Inflows／Outflows = 385
Yield Spreads = 385
Default Rates = 385
Degree of Risk : Placement on the Credit Spectrum = 386
Volatility Considerations = 388
Liquidity Requirements = 388
Yield Management = 389
Portfolio Turnover = 389
Conclusion = 390
Chapter 21 Monitoring a High Yield Portfolio = 391
Introduction = 391
Monitoring Existing Holdings = 391
Monitoring Alternative Investments = 396
Monitoring the Overall Portfolio = 396
Issuer or Company Concentration = 398
Industry Concentration = 399
Concentration by Security Type = 399
Cyclical Versus Noncyclical Exposure = 399
Monitoring Investor Objectives and Constraints = 400
Summary = 400
Chapter 22 Modeling High Yield Bond Portfolios with Correlated Interest Rate and Credit Risk = 401
Introduction = 401
Simulation Methodology = 402
Study Assumptions and Limitations = 403
Interest Rate Risk Simulation Results = 405
Bond Rating Transition Probabilities = 406
Arbitrage Test = 407
Correlated Interest Rate and Credit Risk Simulation with Industry Concentration and High Equity Volatility = 407
Correlated Interest Rate and Credit Risk Simulation with Industry Diversification and High Equity Volatility = 408
Correlated Interest Rate and Credit Risk Simulation with Industry Diversification and Average Equity Volatility = 410
Comparison of Different Risk Asscssment Methodologies and the Significance of Equity Volatility Assumptions = 410
Summary = 412
References = 412
PART SIX INVESTING IN DISTRESSED SECURITIES
Chapter 23 Do Seniority Provision Protect Bondholders' Investments? = 415
Introduction = 415
Literature Review = 417
Data and Methodology = 418
Data = 418
Post-Default performance of Bonds = 419
Loss Measures = 420
Sample Selection Bias Issues = 422
Empirical Results = 422
Prices at Issuance and Emergence = 422
Efficiency Tests at Default = 423
Loss Measures = 424
Loss by Seniority = 427
Summary and Conclusions = 428
Endnotes = 429
References = 429
Chapter 24 Investing in Distressed Situations : A Market Survey = 431
Preface = 431
Introduction = 432
Basic Restructuring Options = 435
Strategies for Creating Value = 436
Proactive Investment Strategies = 438
Taking Control of the Business = 438
"Bondmail" = 440
Passive Investment Strategies = 442
Risk of Investing in a Distressed Situation = 444
The "J" Factor = 444
Title Risk and the Mechanics of Transferring Claims = 446
Risk of Buying "Defective Merchandise" = 449
Disputed and Contingent Claims = 452
Counting Votes = 453
Disqualification of Votes = 454
Holding Period Risk = 456
The Strategic Role of Valuation = 458
Lack of Information about Purchases and Purchasers = 460
Liquidation Risk = 461
Insider Trading Issues = 462
Tax Issues = 463
Exit Strategies and Liquidity Risk = 464
Do Vultures Add or Subtract Value in a Reorganization? = 466
Conclusion = 468
Appendix Rules for Confirming a Chapter 11 Plan of Reorganization = 470
Consensual Plans = 470
Nonconsensual Plans = 470
The Feasibility Test = 471
Chapter 25 Analyzing the Credit Risk of Distressed Securities = 473
Introduction = 473
Terminology = 474
The Life Cycle of a Bankruptcy = 474
Investment Analysis = 476
Causes of Failure = 476
The industry and Company Operating Results = 476
Types of Bankruptcy or Restructuring = 477
Positioning in the Capital Structure = 478
Buying the Company versus Investing = 478
Creditors' Committees = 479
Record of the Judge = 479
Timing = 480
Valuation = 480
Assets = 480
The Enterprise Value(TEV) = 481
The Plan = 482
The Tranche = 483
Matrix Valuation Approach = 483
Caveats = 485
Conclusion = 486
PART SEVEN CORPORATE FINANCE
Chapter 26 Strategic Financing Choices for Emerging Firms : Debt versus Equity = 489
Introduction = 489
Conceptual Framework = 489
Financing Alternative = 491
Capital Markets = 491
Bank Loans = 492
Joint Venture or Partnership Arrangement = 492
Private Capital Infusions = 492
Internally Generated Funds = 493
Pros and Cons of Using These Sources = 493
Dept versus Equity = 494
Cost of Equity = 494
Cost of Debt = 498
Fundamental Issues = 499
Structure of Debt = 501
Secured Debt versus Unsecured Debt = 501
Senior Debt versus Subordinated Debt = 502
Covenants = 502
Maturity Term = 502
Cash-Pay Bands versus Zero Coupon Bonds = 503
Call Feature = 504
Private versus Public Debt = 504
Frequency of Issuance and Reputation of Issuer = 504
Importance of the Rating Agency on Bond Pricing = 505
Summary and Conclusions = 505
Chapter 27 The Advantages and Disadvantages of Public versus Private Issuances of High Yield Debt Securities = 507
Ⅰ. Introduction = 507
Ⅱ. The Public Sale of High Yield Debt Securities = 510
A. Overview of Applicable Federal and State Securities Laws = 510
B. The Federal Registration Process = 511
C. The Trust Indenture Act = 515
D. State Securities Laws = 516
E. The Exchange Act = 518
F. Federal Antifraud Provisions = 519
Ⅲ. The Private Sale of High Yield Debt Securities = 520
A. Overview = 520
B. Regulation D Private Placement Market = 521
C. Rule 144a Private Placement Market = 524
D. Registration Rights Generally = 526
Ⅳ. The Advantages and Disadvantages of Public versus Private High Yield Debt lssuances = 527
A. Pricing Considerations = 527
B. Potential Investor Participation = 528
C. Size of the Offering = 528
D. Secondary Market Liquidity and Trading = 529
E. Registration = 529
F. Disclosure = 530
G. Expenses = 530
H. Timing = 531
I. Underwriting = 531
J. Public Ratings = 531
K. Covenants and Other Terms = 532
Ⅴ. Conclusion = 532
Endnotes = 534
Chapter 28 Managing Default : Some Evidence on How Firms Choose between Workouts and Chapter 11 = 546
Introduction = 546
Costs of Workouts versus Chapter 11 = 548
Legal and Professional Fees = 548
Management by Bankruptcy Judges = 550
Lost Investment Opportunities = 551
How Do Shareholders Fare? = 553
Adventages of Chapter 11 = 554
The Holdout Problem = 555
Incentives of Managers and Directors = 557
Policy Implications = 558
Index = 561
