What is a bond?
A surety bond or surety is a promise to pay one party (the obligee) a certain amount if a second party (the principal) fails to meet some obligation, such as fulfilling the terms of a contract. The surety bond protects the obligee against losses resulting from the principal's failure to meet the obligation.
A surety bond is a contract among at least three parties:
European surety bonds are issued by banks and are called "Bank Guarantees" in English and "Caution" in French. They pay out cash to the limit of guarantee in the event of the default of the Principal to uphold his obligations to the Obligee, without reference by the Obligee to the Principal and against the Obligee's sole verified statement of claim to the bank.
Through a surety bond, the surety agrees to uphold — for the benefit of the obligee — the contractual promises (obligations) made by the principal if the principal fails to uphold its promises to the obligee. The contract is formed so as to induce the obligee to contract with the principal, i.e., to demonstrate the credibility of the principal and guarantee performance and completion per the terms of the agreement.
The principal will pay a premium (usually annually) in exchange for the bonding company's financial strength to extend surety credit. In the event of a claim, the surety will investigate it. If it turns out to be a valid claim, the surety will pay it and then turn to the principal for reimbursement of the amount paid on the claim and any legal fees incurred.
If the principal defaults and the surety turns out to be insolvent, the purpose of the bond is rendered nugatory. Thus, the surety on a bond is usually an insurance company whose solvency is verified by private audit, governmental regulation, or both.
A key term in nearly every surety bond is the penal sum. This is a specified amount of money which is the maximum amount that the surety will be required to pay in the event of the principal's default. This allows the surety to assess the risk involved in giving the bond; the premium charged is determined accordingly.
Surety bonds are also used in other situations, for example, to secure the proper performance of fiduciary duties by persons in positions of private or public trust.
Annual US surety bond premiums are approximately $3.5 billion. State insurance commissioners are responsible for regulating corporate surety activities within their jurisdictions. The commissioners also license and regulate brokers or agents who sell the bonds.
Individual Surety Bonds are the original form of suretyship. The earliest known record of a contract of suretyship is a Mesopotamian tablet written around 2750 BC. There is evidence of Individual Surety Bonds in the Code of Hammurabi and in Babylon, Persia, Assyria, Rome, Carthage, the ancient Hebrews and later England.
The Code of Hammurabi, written around 1790 BC, was the first time suretyship was addressed in a written legal code.
It wasn't until 1840 that the first Corporate Surety was organized, The Guarantee Society of London.
In 1865, the Fidelity Insurance Company became the first US Corporate Surety company, but the venture soon failed.
Contract surety bonds
Contract bonds, used heavily in the construction industry by general contractors as a part of construction law, are a guarantee from a Surety to a project's owner (Obligee) that a general contractor (Principal) will adhere to the provisions of a contract. The Associated General Contractors of America, a United States trade association, provides some information for their members on these bonds. Contract bonds are not the same thing as contractor's license bonds, which may be required as part of a license.
Included in this category are: bid bonds (guarantee that a contractor will enter into a contract if awarded the bid), performance bonds (guarantee that a contractor will perform the work as specified by the contract), payment bonds (guarantee that a contractor will pay for services, particularly subcontractors and materials and particularly for federal projects where a mechanic's lien is not available), and maintenance bonds (guarantee that a contractor will provide facility repair and upkeep for a specified period of time). There are also miscellaneous contract bonds that do not fall within the categories above, the most common of which are subdivision and supply bonds. Bonds are typically required for federal government projects by the Miller Act and state projects under "little Miller Acts". In federal government, the contract language is determined by the government. In private contracts the parties may freely contract the language and requirements. Standard form contracts provided by American Institute of Architects (AIA) and the Associated General Contractors of America (AGC) make bonding optional. If the parties agree to require bonding, additional forms such as the performance bond contract AIA Document 311 provide common terms.
Losses arise when contractors do not complete their contracts, which often arises when the contractor goes out of business. Contractors often go out of business; for example, a study by BizMiner found that of 853,372 contracts in the United States in 2002, 28.5% had exited business by 2004. The average failure rate of contractors in the United States from 1989 to 2002 was 14 percent versus 12 for other industries.
Prices are as a percent of the penal sum (the maximum that the surety is liable for) ranging from around one percent to five percent, with the most credit-worthy contracts paying the least. The bond typically includes an indemnity agreement whereby the principal contractor or others agree to indemnify the surety if there is a loss. In the United States, the Small Business Administration may guarantee surety bonds; in 2013 the eligible contract tripled to $6.5 million.
Commercial surety bonds
Commercial bonds represent the broad range of bond types that do not fit the classification of contract. They are generally divided into four sub-types: license and permit, court, public official, and miscellaneous.
License and permit bonds
License and permit bonds are required by certain federal, state, or municipal governments as prerequisites to receiving a license or permit to engage in certain business activities. These bonds function as a guarantee from a Surety to a government and its constituents (Obligee) that a company (Principal) will comply with an underlying statute, state law, municipal ordinance, orregulation.
Specific examples include:
Court bonds are those bonds prescribed by statute and relate to the courts. They are further broken down into judicial bonds and fiduciary bonds. Judicial bonds arise out of litigation and are posted by parties seeking court remedies or defending against legal actions seeking court remedies. Fiduciary, or probate, bonds are filed in probate courts and courts that exercise equitable jurisdiction; they guarantee that persons whom such courts have entrusted with the care of others’ property will perform their specified duties faithfully.
Examples of judicial bonds include appeal bonds, supersedeas bonds, attachment bonds, replevin bonds, injunction bonds, Mechanic's lien bonds, and bail bonds. Examples of fiduciary bonds include administrator, guardian, and trustee bonds.
Public official bonds
Public official bonds guarantee the honesty and faithful performance of those people who are elected or appointed to positions of public trust. Examples of officials sometimes requiring bonds include: notaries public, treasurers, commissioners, judges, town clerks, law enforcement officers, and Credit Union volunteers.
Miscellaneous bonds are those that do not fit well under the other commercial surety bond classifications. They often support private relationships and unique business needs. Examples of significant miscellaneous bonds include: lost securities bonds, hazardous waste removal bonds, credit enhancement financial guarantee bonds, self–insured workers compensation guarantee bonds, and wage and welfare/fringe benefit (Union) bonds.
Fidelity bonds, also known as employee dishonesty coverage, cover theft of an employer's property by its own employees. Though referred to as bonds, fidelity coverage functions as a traditional insurance policy rather than a surety bond.
From Wikipedia, the free encyclopedia
(Redirected from James bond)
This article is about the spy series in general. For other uses, see James Bond (disambiguation).
James Bond, 007 character
Casino Royale, 1953 novel
Skyfall, 2012 film
Daniel Craig (2006–present)
Toby Stephens (2008–2012)
Andrew Bond (Father)
James Suzuki Bond (son with Kissy)
Charmian Bond (Aunt)
James Bond, code name 007, is a fictional character created in 1953 by writer Ian Fleming, who featured him in twelve novels and two short-story collections. Six other authors have written authorised Bond novels or novelizations since Fleming's death in 1964: Kingsley Amis, Christopher Wood,John Gardner, Raymond Benson, Sebastian Faulks, and Jeffery Deaver; a new novel, written by William Boyd, is planned for release in 2013.Additionally, Charlie Higson wrote a series on a young James Bond, and Kate Westbrook wrote three novels based on the diaries of a recurring series character, Moneypenny.
The fictional British Secret Service agent has also been adapted for television, radio, comic strip, and video game formats in addition to having been used in the longest continually running and the second-highest grossing film series to date, which started in 1962 with Dr. No, starring Sean Conneryas Bond. As of 2013, there have been twenty-three films in the Eon Productions series. The most recent Bond film, Skyfall (2012), stars Daniel Craigin his third portrayal of Bond; he is the sixth actor to play Bond in the Eon series. There have also been two independent productions of Bond films:Casino Royale (a 1967 spoof) and Never Say Never Again (a 1983 remake of an earlier Eon-produced film, Thunderball).
The Bond films are renowned for a number of features, including the musical accompaniment, with the theme songs having received Academy Awardnominations on several occasions, and one win. Other important elements which run through most of the films include Bond's cars, his guns, and the gadgets with which he is supplied by Q Branch.
Savings bonds were created to finance World War I, and were originally called Liberty Bonds. Unlike Treasury Bonds, they are not marketable. In 2002, the Treasury Department started changing the savings bond program by lowering interest rates and closing its marketing offices. As of January 1, 2012, financial institutions no longer sell paper savings bonds. The annual (calendar year) purchase limit for electronic Series EE and Series I savings bonds is $10,000 for each series. The limit is applied per Social Security Number (SSN) or Taxpayer Identification Number (TIN). For paper Series I Savings Bonds purchased through IRS tax refunds (see below), the purchase limit is $5,000 per SSN, which is in addition to the online purchase limit.
$1,000 Series EE Savings Bond featuringBenjamin Franklin
Series EE bonds reach maturity (double in value) 20 years from issuance though they continue to earn interest for a total of 30 years. Interest accrues monthly and is paid when the holder cashes the bond. For bonds issued before May 2005 the rate of interest is recomputed every six months at 90% of the average five-year Treasury yield for the preceding six months. Bonds issued in May 2005 or later pay a fixed interest rate for the life of the bond (0.20% in November 2012). At 0.20%, a $100 bond would be worth less than $105 just before 20 years, but will be adjusted to the maturity value of $200 at 20 years (giving it an effective rate of 3.5%) then continue to earn the fixed rate for 10 more years. In the space of a decade, interest dropped from well over 5% to 0.7% for new bonds in 2009. Paper EE bonds were issued with a face value of twice their purchase price, so a $100 bond could be bought for $50, but would not be worth $100 until maturity.
Series I bonds have a variable yield based on inflation. The interest rate consists of two components: the first is a fixed rate which will remain constant over the life of the bond. The second component is a variable rate reset every six months from the time the bond is purchased based on the current inflation rate. New rates are published on May 1 and November 1 of every year. The fixed rate is determined by the Treasury Department (0% in November 2012); the variable component is based on the Consumer Price Index (CPI-U) from a six-month period ending one month prior to the reset time (0.878% in November 2012, reflecting the CPI-U from March to September, published in mid-October, for an effective annual inflation rate of 1.76%). As an example, if someone purchases a bond in February, they will lock in the current fixed rate forever, but the inflation component will be based on the rate published the previous November. In August, six months after the purchase month, the inflation component will now change to the rate that was published in May while the fixed rate remains locked. Interest accrues monthly, in full, on the first day of the month (i.e., a Savings Bond will have the same value on July 1 as on July 31, but on August 1 its value will increase for the August interest accrual). The fixed portion of the rate has varied from as much as 3.6% to 0%. During times of deflation (during part of 2009), the negative inflation portion can wipe out the return of the fixed portion, but the combined rate cannot go below 0% and the bond will not lose value.
Besides being available for purchase online, tax payers may purchase I-bonds using a portion of their tax refund via IRS Form 8888 Allocation of Refund. Bonds purchased using Form 8888 are issued as paper bonds and mailed to the address listed on the tax return. Tax payers may purchase bonds for themselves or other persons such as children or grandchildren. The remainder of the tax payer's refund may be received by direct deposit or check.
Series HH bonds have been discontinued. Unlike Series EE and I bonds, they do not increase in value, but pay interest every six months for 20 years. When they are cashed in or mature they are still worth face value. Issuance of Series HH bonds ended August 31, 2004.
A corporate bond is a bond issue by a corporation. It is a bond that a corporation issues to raise money effectively in order to expand its business. The term is usually applied to longer-term debt instruments, generally with a maturity date falling at least a year after their issue date. (The term "commercial paper" is sometimes used for instruments with a shorter maturity.)
Sometimes, the term "corporate bonds" is used to include all bonds except those issued by governments in their own currencies. Strictly speaking, however, it only applies to those issued by corporations. The bonds of local authorities and supranational organizations do not fit in either category.[clarification needed]
Corporate bonds are often listed on major exchanges (bonds there are called "listed" bonds) and ECNs, and the coupon (i.e. interest payment) is usually taxable. Sometimes this coupon can be zero with a high redemption value. However, despite being listed on exchanges, the vast majority of trading volume in corporate bonds in most developed markets takes place in decentralized, dealer-based, over-the-counter markets.
Some corporate bonds have an embedded call option that allows the issuer to redeem the debt before its maturity date. Other bonds, known as convertible bonds, allow investors to convert the bond into equity.
Corporate Credit spreads may alternatively be earned in exchange for default risk through the mechanism of Credit Default Swaps which give an unfunded synthetic exposure to similar risks on the same 'Reference Entities'. However, owing to quite volatile CDS 'basis' the spreads on CDS and the credit spreads on corporate bonds can be significantly different.
Corporate debt fall into several broad categories:
Generally, the higher one's position in the company's capital structure, the stronger one's claims to the company's assets in the event of a default.
Compared to government bonds, corporate bonds generally have a higher risk of default. This risk depends on the particular corporation issuing the bond, the current market conditions and governments to which the bond issuer is being compared and the rating of the company. Corporate bond holders are compensated for this risk by receiving a higher yield than government bonds. The difference in yield reflects the higher probability of default, the expected loss in the event of default, and may also reflect liquidity and risk premia.
Other risks in Corporate Bonds
-Default Risk has been discussed above but there are also other risks for which corporate bondholders expect to be compensated by credit spread. This is, for example why the Option Adjusted Spread on a Ginnie Mae MBS will usually be higher than zero to the Treasury curve.
-Credit Spread Risk. The risk that the credit spread of a bond (extra yield to compensate investors for taking default risk), which is inherent in the fixed coupon, becomes insufficient compensation for default risk that has later deteriorated. As the coupon is fixed the only way the credit spread can readjust to new circumstances is by the market price of the bond falling and the yield rising to such a level that an appropriate credit spread is offered.
-Interest Rate Risk. The level of Yields generally in a bond market, as expressed by Government Bond Yields, may change and thus bring about changes in the market value of Fixed-Coupon bonds so that their Yield to Maturity adjusts to newly appropriate levels.
-Liquidity Risk. There may not be a continuous secondary market for a bond, thus leaving an investor with difficulty in selling at, or even near to, a fair price. This particular risk could become more severe in developing markets, where a large amount of junk bonds belong, such as China, Vietnam, Indonesia, etc.
-Supply Risk. Heavy issuance of new bonds similar to the one held may depress their prices.
-Inflation Risk. Inflation reduces the real value of future fixed cash flows. An anticipation of inflation, or higher inflation, may depress prices immediately.
-Tax Change Risk. Unanticipated changes in taxation may adversely impact the value of a bond to investors and consequently its immediate market value.
Corporate bond indices
See also: bond market index
Corporate bond indices include the Barclays Corporate Bond Index, S&P U.S. Issued Investment Grade Corporate Bond Index (SPUSCIG), the Citigroup US Broad Investment Grade Credit Index, and the Dow Jones Corporate Bond Index.
Corporate bond market transparency
Speaking in 2005, SEC Chief Economist Chester S. Spatt offered the following opinion on the transparency of corporate bond markets:
Frankly, I find it surprising that there has been so little attention to pre-trade transparency in the design of the U.S. bond markets. While some might argue that this is a consequence of the degree of fragmentation in the bond market, I would point to options markets and European bond markets-which are similarly fragmented, but much more transparent on a pre-trade basis.
A combination of mathematical and regulatory initiatives are aimed at addressing pre-trade transparency in the U.S. corporate bond markets.
A chemical bond is an attraction between atoms that allows the formation of chemical substances that contain two or more atoms. The bond is caused by the electrostatic force of attraction between opposite charges, either between electrons and nuclei, or as the result of a dipole attraction. The strength of chemical bonds varies considerably; there are "strong bonds" such ascovalent or ionic bonds and "weak bonds" such as dipole–dipole interactions, the London dispersion force and hydrogen bonding.
Since opposite charges attract via a simple electromagnetic force, the negatively charged electrons that are orbiting the nucleus and the positively charged protons in the nucleus attract each other. An electron positioned between two nuclei will be attracted to both of them, and the nuclei will be attracted toward electrons in this position. This attraction constitutes the chemical bond. Due to the matter wave nature of electrons and their smaller mass, they must occupy a much larger amount of volume compared with the nuclei, and this volume occupied by the electrons keeps the atomic nuclei relatively far apart, as compared with the size of the nuclei themselves. This phenomenon limits the distance between nuclei and atoms in a bond.
In general, strong chemical bonding is associated with the sharing or transfer of electrons between the participating atoms. The atoms in molecules, crystals, metals and diatomic gases— indeed most of the physical environment around us— are held together by chemical bonds, which dictate the structure and the bulk properties of matter.
A municipal bond is a bond issued by a local government, or their agencies. Potential issuers of municipal bonds include states, cities, counties, redevelopment agencies, special-purpose districts, school districts, public utility districts, publicly owned airports and seaports, and any other governmental entity (or group of governments) at or below the state level. Municipal bonds may be general obligations of the issuer or secured by specified revenues.
In the United States, interest income received by holders of municipal bonds is often exempt from the federal income tax and from the income tax of the state in which they are issued, although municipal bonds issued for certain purposes may not be tax exempt.
Unlike new issue stocks that are brought to market with price restrictions until the deal is sold, municipal bonds are free to trade at any time once they are purchased by the investor. Professional traders regularly trade and retrade the same bonds several times a week.
A bail bond agent, or bondsman, is any person or corporation that will act as a surety and pledge money or property as bail for the appearance ofpersons accused in court. Although banks, insurance companies and other similar institutions are usually the sureties on other types of contracts (for example, to bond a contractor who is under a contractual obligation to pay for the completion of a construction project) such entities are reluctant to put their depositors' or policyholders' funds at the kind of risk involved in posting a bail bond. Bail bond agents, on the other hand, are usually in the business to cater to criminal defendants, often securing their customers' release in just a few hours.
Bail bond agents are almost exclusively found in the United States and its former commonwealth, the Philippines. In most other countries bail is usually much less and the practice of bounty hunting is illegal. The industry is represented by various trade associations, with the American Bail Coalition forming an umbrella group in the United States.
The first modern bail bonds business in the US, the system by which a person pays a percentage of the court-specified bail amount to a professional bonds agent who puts up the cash as a guarantee that the person will appear in court, was established by Tom and Peter P. McDonough in San Francisco in 1898.
Bond agents have a standing security agreement with local court officials, in which they agree to post an irrevocable "blanket" bond, which will pay the court if any defendant for whom the bond agent is responsible does not appear. The bond agent usually has an arrangement with an insurance company, bank or another credit provider to draw on such security, even during hours when the bank is not operating. This eliminates the need for the bondsman to deposit cash or property with the court every time a new defendant is bailed out. The laws on bail bonds are generally inconsistent throughout the United States. Federal laws affecting it include the Eighth Amendment to the United States Constitution (which contains the Excessive Bail Clause) and the Bail Reform Act of 1984, which was included in the Comprehensive Crime Control Act of 1984. The Uniform Criminal Extradition Act sponsored by the Uniform Law Commission is widely adopted.
All bail bond agents have lengthy bail bond agreements. All agreements in California are to be verified and certified by the California Department of Insurance. Most bail bond agreements are given to the bail bond agents by their insurers, and the insurers have already verified and certified all bail bond agreements for their agents.
A "24 hours a day" bail bonds office opposite the Contra Costa County Detention Center in Martinez, CA
Bond agents generally charge a fee of 10-15% of the total amount of the bail, with a minimum of $100 in some states like Florida, required in order to post a bond for the amount. This fee is not refundable and represents the bond agent's compensation for his or her services. Some states, such as North Carolina, charge a flat 15% where other states that charge 10% can also bill the defendant for phone calls, gas, mileage, anything that has to do with the apprehension of the subject, etc. One argument for abolishing the bail bonding industry is that when a bailed defendant flees, the state does not receive the full bond amount from the bond agent but only a percentage which is often as low as 5%. This means that the bond agent makes a 5% - 10% profit at the states' expense even when the bailed defendant flees. In many locations, such as Dallas, Texas, bail bondsmen owe thousands of dollars in forfeit fees. However, in some states such as Florida, this is not the case. Bondsmen are responsible for paying the forfeitures, and if they do not pay the full amount, they can no longer write bonds in the state.
As an alternative, some courts have recently instituted a practice of accepting 10% of the bond amount in cash, for example, by requiring a $10,000 bond or $1,000 in cash. In jurisdictions where the 10% cash alternative is available, the deposit is usually returned if the case is concluded without violation of the conditions of bail. This has the effect of giving the defendant or persons giving security for the defendant a substantial incentive to make the cash deposit rather than using a bail bond agent.
For large bail amounts, bond agents can generally obtain security against the assets of the defendant or persons willing to assist the defendant. For example, for a $100,000 bond for a person who owns a home, the bond agent would charge $10,000 and take a mortgage against the house for the full penal sum of the bond.
If the defendant fails to appear in court, the bond agent is allowed by law and/or contractual arrangement to bring the defendant to the jurisdiction of the court in order to recover the money paid out under the bond, usually through the use of a bounty hunter. Some states, such as North Carolina, have outlawed the use or licensing of "bounty hunters" so each bail bondsman must re-apprehend his own fugitives. The bond agent is also allowed to sue the indemnitors, any persons who guaranteed the defendants appearance in court, and or defendant for any money forfeited to the court should the defendant fail to appear.[clarification needed]
In most jurisdictions, bond agents have to be licensed to carry on business within the state. There are some more seemingly unlikely organizations that often provide bail bonds. AAA, for instance, will often extend its auto coverage to include local bail bonds for traffic related arrests. This provides an extra service to their members, and frees the member from needing immediate cash.
Four states — Illinois, Kentucky, Oregon, and Wisconsin — have completely banned commercial bail bonding, usually substituting the 10% cash deposit alternative described above. However, some of these states specifically allow AAA and similar organizations to continue providing bail bond services pursuant to insurance contracts or membership agreements.
The economically discriminatory effect of the bond system has been controversial and subject to attempts at reform since the 1910s. The market evidence indicates that judges in setting bail demanded lower probabilities of flight from minority defendants. See, for example, Frank Murphy's institution of a bond department at Detroit, Michigan's Recorder's Court. Furthermore, the economic incentives of bonding for profit make it less likely that defendants charged with minor crimes (who are assigned lower amounts of bail) will be released. This is because a bail bondsman will not find it profitable to work on matters where the percentage of profit would yield $10 or $20. As such, bail bondsmen help release people with higher amounts of bail who are also charged with higher crimes, creating an imbalance in the numbers of people charged with minor crimes (low level misdemeanors) and increasing jail expenditures for this category of crimes.
Several high-profile cases involving bondsman misconduct have led to calls for increased regulation of the industry and/or outright abolition of the bail for profit industry. One of the most prominent cases in Louisiana, involved bribery of judges by a bail bonding agency and, after a far-reaching FBI investigation—code name “Operation Wrinkled Robe”—led to criminal charges and removal proceedings for various judges and police officers.
In addition to the use of bail bonds, a defendant may be released under other terms. These alternatives include pretrial services programs, own recognizance or signature bond, cash bond, surety bond, property bond, and citation release. The choice of these alternatives is determined by the court.
A fidelity bond is a form of insurance protection that covers policyholders for losses that they incur as a result of fraudulent acts by specified individuals. It usually insures a business for losses caused by the dishonest acts of its employees.
While called bonds, these obligations to protect an employer from employee-dishonesty losses are really insurance policies. These insurance policies protect from losses of company monies,securities, and other property from employees who have a manifest intent to cause the company loss. There are also many other forms of crime-insurance policies (burglary, fire, general theft, computer theft, disappearance, fraud, forgery, etc.) to protect company assets.
A bearer bond is a debt security issued by a business entity, such as a corporation, or by a government. It differs from the more common types of investment securities in that it is unregistered – no records are kept of the owner, or the transactions involving ownership. Whoever physically holds the paper on which the bond is issued owns the instrument. This is useful for investors who wish to retain anonymity. Recovery of the value of a bearer bond in the event of its loss, theft, or destruction is usually impossible. Some relief is possible in the case of United States public debt.
Bearer bonds have historically been the financial instrument of choice for money laundering, tax evasion, and concealed business transactions in general. In response, new issuances of bearer bonds have been severely curtailed in the United States since 1982.
In the United States all the bearer bonds issued by the US Treasury have matured. They no longer pay interest to the holders. As of May 2009, the approximate amount outstanding is $100 million.
In June 2009, Italian financial police and custom guards seized documents purporting to be US bearer bonds, totalling $134.5 billion. The bonds were in $500 million and $1 billion denominations, although the highest denomination ever issued by the US Treasury was $1,000,000. It was unclear what the purpose of the fake bonds was; the two men carrying them were not detained after the bonds were seized.
In the United States, since the passage of the Tax Equity and Fiscal Responsibility Act of 1982, the issuance of debt in bearer form has been substantially curtailed. The interest paid on any such bonds issued after 1982 would not be tax-deductible by the issuer in the case of corporate bonds, and taxable income to the holder in the case of municipal bonds. In contrast, registered bonds retain favorable tax treatment.
In finance, a high-yield bond (non-investment-grade bond, speculative-grade bond, or junk bond) is a bond that is rated below investment grade. These bonds have a higher risk of default or other adverse credit events, but typically pay higher yields than better quality bonds in order to make them attractive to investors.
Global high yield bond (debt) issuance is disproportionately centered in the United States, although issuers in Europe, Asia and South Africa have turned to high-yield debt in connection with refinancings and acquisitions. After a lull during the 2008 financial markets meltdown, European high yield bond issuance peaked in 2010, with some €44 billion in volume. During the first 5 months of 2013, however, refinancings propelled European high yield issuance to more than €31 billion, a pace that would easily top the 2010 total. In the US, high yield bond issuance has surged since the financial market meltdown of 2008–09, culminating in a record $346 billion in offerings during 2012, easily besting the then-record $287 billion seen in 2010.
The 2013 US high yield debt market took off where 2012 ended, pricing more than $31 billion in deals during the first month of the year, making it the busiest January on record. The eye-popping volume (and accompanying record-low yields) comes amid sustained institutional investor appetite and a quest for higher yielding paper.
The bond market cooled noticeably in February, however, as institutional investors – put off by record-low yields, among other things – began to take money out of high yield (often placing it into the leveraged loan market). Consequently, US high yield bond issuance slowed to $23 billion in February 2013. High yield issuance rebounded to $35 billion in March, however, bringing volume for the first quarter of 2013 to $90.4 billion, just off the record $96 billion seen in the fourth quarter of 2012. High yield issuance tailed off in April however, to $26 billion in the U.S., as refinancing activity slowed. Indeed, by June monthly high yield bond issuance in the U.S. had slumped to $12.8 billion – the lowest monthly total since June 2012 – amid a major sell-off in the market, as investors became wary of rising rates. The second quarter of 2013 saw $82.5 billion in U.S. high yield bond activity.
The holder of any debt is subject to interest rate risk and credit risk, inflationary risk, currency risk, duration risk, convexity risk, repayment of principal risk, streaming income risk, liquidity risk, default risk, maturity risk, reinvestment risk, market risk, political risk, and taxation adjustment risk. Interest rate risk refers to the risk of the market value of a bond changing in value due to changes in the structure or level of interest rates or credit spreads or risk premiums. The credit risk of a high-yield bond refers to the probability and probable loss upon a credit event (i.e., the obligor defaults on scheduled payments or files for bankruptcy, or the bond is restructured), or a credit quality change is issued by a rating agency including Fitch, Moody's, or Standard & Poors.
A credit rating agency attempts to describe the risk with a credit rating such as AAA. In North America, the five major agencies are Standard and Poor's, Moody's,Fitch Ratings, Dominion Bond Rating Service and A.M. Best. Bonds in other countries may be rated by US rating agencies or by local credit rating agencies. Rating scales vary; the most popular scale uses (in order of increasing risk) ratings of AAA, AA, A, BBB, BB, B, CCC, CC, C, with the additional rating D for debt already inarrears. Government bonds and bonds issued by government sponsored enterprises (GSEs) are often considered to be in a zero-risk category above AAA; and categories like AA and A may sometimes be split into finer subdivisions like "AA−" or "AA+".
Bonds rated BBB− and higher are called investment grade bonds. Bonds rated lower than investment grade on their date of issue are called speculative grade bonds, or colloquially as "junk" bonds.
The lower-rated debt typically offers a higher yield, making speculative bonds attractive investment vehicles for certain types of financial portfolios and strategies. Many pension funds and other investors (banks, insurance companies), however, are prohibited in their by-laws from investing in bonds which have ratings below a particular level. As a result, the lower-rated securities have a different investor base than investment-grade bonds.
The value of speculative bonds is affected to a higher degree than investment grade bonds by the possibility of default. For example, in a recession interest rates may drop, and the drop in interest rates tends to increase the value of investment grade bonds; however, a recession tends to increase the possibility of default in speculative-grade bonds.
The original speculative grade bonds were bonds that once had been investment grade at time of issue, but where the credit rating of the issuer had slipped and the possibility of default increased significantly. These bonds are called "fallen angels".
The investment banker Michael Milken realized that fallen angels had regularly been valued less than what they were worth. His time with speculative grade bonds started with his investment in these. Only later did he and other investment bankers at Drexel Burnham Lambert, followed by those of competing firms, begin organizing the issue of bonds that were speculative grade from the start. Speculative grade bonds thus became ubiquitous in the 1980s as a financing mechanism in mergers and acquisitions. In a leveraged buyout (LBO) an acquirer would issue speculative grade bonds to help pay for an acquisition and then use the target's cash flow to help pay the debt over time.
In 2005, over 80% of the principal amount of high-yield debt issued by U.S. companies went toward corporate purposes rather than acquisitions or buyouts.
In emerging markets, such as China and Vietnam, bonds have become increasingly important as term financing options, since access to traditional bank credits has always been proved to be limited, especially if borrowers are non-state corporates. The corporate bond market has been developing in line with the general trend of capital market, and equity market in particular.
High-yield bonds can also be repackaged into collateralized debt obligations (CDO), thereby raising the credit rating of the senior tranches above the rating of the original debt. The senior tranches of high-yield CDOs can thus meet the minimum credit rating requirements of pension funds and other institutional investors despite the significant risk in the original high-yield debt.
The New York City headquarters of Barclays (formerly Lehman Brothers, as shown in the picture). In background, theAXA Center, headquarters of AXA, first worldwide insurance company.
When such CDOs are backed by assets of dubious value, such as subprime mortgage loans, and lose market liquidity, the bonds and their derivatives become what is referred to as "toxic debt". Holding such "toxic" assets has led to the demise of several investment banks such as Lehman Brothersand other financial institutions during the subprime mortgage crisis of 2007–09 and led the US Treasury to seek congressional appropriations to buy those assets in September 2008 to prevent a systemic crisis of the banks.
Such assets represent a serious problem for purchasers because of their complexity. Having been repackaged maybe several times, it is difficult and time-consuming for auditors and accountants to determine their true value. As the recession of 2008–09 bites, their value is decreasing further as more debtors default, so they represent a rapidly depreciating asset. Even those assets that might have gone up in value in the long-term are now depreciating rapidly, quickly becoming "toxic" for the banks that hold them. Toxic assets, by increasing the variance of banks' assets, can turn otherwise healthy institutions into zombies. Potentially insolvent banks have made too few good loans creating a debt overhang problem.Alternatively, potentially insolvent banks with toxic assets will seek out very risky speculative loans to shift risk onto their depositors and other creditors.
On March 23, 2009, U.S. Treasury Secretary Timothy Geithner announced a Public-Private Investment Partnership (PPIP) to buy toxic assets from banks' balance sheets. The major stock market indexes in the United States rallied on the day of the announcement rising by over six percent with the shares of bank stocks leading the way. PPIP has two primary programs. The Legacy Loans Program will attempt to buy residential loans from banks' balance sheets. The Federal Deposit Insurance Corporation will provide non-recourse loan guarantees for up to 85 percent of the purchase price of legacy loans. Private sector asset managers and the U.S. Treasury will provide the remaining assets. The second program is called the legacy securities program which will buy mortgage backed securities (RMBS) that were originally rated AAA and commercial mortgage-backed securities (CMBS) and asset-backed securities (ABS) which are rated AAA. The funds will come in many instances in equal parts from the U.S. Treasury'sTroubled Asset Relief Program monies, private investors, and from loans from the Federal Reserve's Term Asset Lending Facility (TALF). The initial size of the Public Private Investment Partnership is projected to be $500 billion. Nobel Prize winning economist and former Enron advisor Paul Krugmanhas been very critical of this program arguing the non-recourse loans lead to a hidden subsidy that will be split by asset managers, banks' shareholders and creditors. Banking analyst Meredith Whitney argues that banks will not sell bad assets at fair market values because they are reluctant to take asset write downs. Removing toxic assets would also reduce the volatility of banks' stock prices. Because stock is akin to a call option on a firm's assets, this lost volatility will hurt the stock price of distressed banks. Therefore, such banks will only sell toxic assets at above market prices.
See also: Bond market index
High-yield bond indices exist for dedicated investors in the market. Indices for the broad high-yield market include the S&P U.S. Issued High Yield Corporate Bond Index (SPUSCHY), CSFB High Yield II Index (CSHY), Citigroup US High-Yield Market Index, the Merrill Lynch High Yield Master II (H0A0), the Barclays High Yield Index, and the Bear Stearns High Yield Index (BSIX). Some investors, preferring to dedicate themselves to higher-rated and less-risky investments, use an index that only includes BB-rated and B-rated securities, such as the Merrill Lynch Global High Yield BB-B Rated Index (HW40). Other investors focus on the lowest quality debt rated CCC or distressed securities, commonly defined as those yielding 1500 basis points over equivalent government bonds.
See also: European sovereign debt crisis
On 27 April 2010, the Greek debt rating was decreased to "junk" status by Standard & Poor's amidst fears of default by the Greek Government. They also cut Portugal's credit ratings by two notches to A, over concerns about its state debt and public finances on 28 April. On 5 July 2011, Portugal's rating was decreased to "junk" status by Moody's (by four notches from Baa1 to Ba2) saying there was a growing risk the country would need a second bail-out before it was ready to borrow money from financial markets again, and private lenders might have to contribute.
On 13 July 2012, Moody's cut Italy's credit rating two notches, to Baa2 (leaving it just above junk). Moody's warned the country it could be cut further.
With the ongoing deleveraging process within the European banking system, many European CFOs are still issuing high-yield bonds. As a result, by the end of September 2012, the total amount of annual primary bond issuances stood at EUR 50 billion. It is assumed that high-yield bonds are still attractive for companies with a stable funding base, although the ratings have declined continuously for most of those bonds.