What is the connection between high-yield bonds and the private equity boom in the 80s?

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Although high-yield or "junk" bonds existed before the 1980s, they were typically bonds that had been investment grade (rated BBB or higher by one of the major credit rating agencies) at the time of issue. When the credit rating of the issuer declined, the bonds were no longer investment grade, and their value declined sharply. Michael Milken, an investment banker with Drexel Burnham Lambert, realized that these bonds were generally undervalued and started organizing bond issues in which all the bonds were initially high-yield and low-rated. This allowed higher risk transactions to take place, since the risk was balanced by a greater potential reward.

High-yield bonds were often used as a method of financing leveraged buyouts, in which the company is purchased with a combination of debt and equity, and its cashflow is used to repay the debt. While the economy was booming in the 1980s, these bonds were very attractive to investors, since few of the issuers were, as yet, defaulting on payments, while the yields were significantly higher than those of investment grade bonds. Private equity funds and venture capitalists were particularly well-placed to take advantage of these high-yield investments, since they were comparatively unregulated, with no inbuilt requirements as to the credit rating of the bonds they accepted as payment. Hence the widespread issue of high-yield bonds was integral to the private equity boom.

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