NEWSWIRE - APRIL 24, 1998
Topic: Junk Bond Financing
Source: "Level 3 Sells Junk Bonds of $2 Billion,"
by Gregory Zuckerman, Wall Street Journal, Friday,
April 24, 1998, page C1.
Synopsis of Article: Last week, a small Nebraska
telecommunications firm went to market with $1.5 billion in
junk bonds but quickly increased the offering to $2 billion
due to strong investor interest. This is the largest non-investment
grade issue in the 1990s and it indicates that junk bonds
are a significant source of long term financing for small,
growth oriented corporations. In fact, high-yield bond issues
are being issued at nearly twice the rate of one year ago
with a total of $53.7 billion sold since the beginning of
the year.
Level 3 (LVLT) is modest sized telecommunications (about
$9 billion market capitalization, $3 billion in assets) that
develops communications networks using fiber optics and other
technologies in the U.S. and Europe. The firm intends to use
the proceeds of the issue to expand operations. The 10-year
senior, unsecured notes were rated B by S&P and B-3 by
Moody's. They sold at par with a coupon (and yield to maturity)
of 9.19%. This is 3.50% higher than 10-year U.S. Treasury
notes.
While these bonds are clearly speculative, it appears investors
are willing to accept the risk to achieve returns well above
safer securities. The article mentions that default rates
among outstanding junk bond issues over the past year is at
2.2%, well under the long term rate of 3.8%. It also compares
the 3.50% spread over Treasuries with an average differential
of 4.50% in the 1990s.
Questions:
1. What is a "junk", or high yield bond? What
is the differential, or spread between the Level 3 notes and
a default-free U.S. Treasury security of the same maturity?
In general, what causes this spread to narrow or widen over
time?
2. What financial ratios will investors in these notes monitor
most closely? How will changes in these ratios influence the
value of the notes?
3. Why didn't Level 3 issue convertible bonds instead? Discuss
the pros and cons of this alternative method of financing.
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