High yield bonds (also called junk bonds, non-investment grade bonds, or speculative grade bonds) are corporate debt instruments rated below investment grade by major rating agencies — BB+/Ba1 or lower — that pay higher interest rates to compensate investors for higher credit risk. The high yield market is a critical component of leveraged finance, providing longer-term fixed-rate capital to companies financing leveraged buyouts, acquisitions, or organic growth.
High yield bonds are typically issued in face amounts of $1,000 per bond, with minimum offering sizes of $200M–$500M or more in the broadly syndicated market. They pay semi-annual fixed-rate coupons and mature in five to eight years. Unlike floating-rate leveraged loans, the fixed-rate nature of HY bonds provides borrowers with certainty about their interest obligations but removes the natural hedge against rising rates that floating-rate lenders enjoy.
The indenture — the governing legal document for a high yield bond — contains extensive covenant packages, though typically less restrictive than bank credit agreements. High yield covenants are primarily incurrence-based (restricting certain actions only when specific tests are failed) rather than maintenance-based (requiring periodic financial tests). Key high yield covenants include a debt incurrence covenant (restricting additional borrowings beyond a fixed charge coverage test), a lien covenant (limiting permitted liens), a restricted payments covenant (limiting dividends, buybacks, and junior debt payments), and asset sale covenants (requiring proceeds to be applied to debt repayment or reinvested in the business).
Call provisions — the right of the issuer to redeem bonds before maturity — are another distinctive feature. High yield bonds are typically non-callable for the first two to three years after issuance ("hard non-call period"), then callable at a premium to par that declines over time (call schedule). These provisions allow issuers to refinance if rates fall but compensate investors for the reinvestment risk.
New issue pricing for high yield bonds is determined through a bookbuild process managed by underwriting banks. The company and its banks assess investor demand at various yield/price levels, ultimately pricing the deal at a yield that clears the market. Secondary market trading occurs over-the-counter (OTC) among broker-dealers and institutional investors; TRACE reporting provides post-trade price transparency to market participants.