BONDS
Written documents by which a government, corporation, or individual – the obligor – promises to perform a certain act, usually the payment of a definite sum of money, to another – the obligee - on a certain date.
In most cases, a bond is issued by a public or
private entity to an investor who, by purchasing
the bond, lends the issuer money. Governments
and corporations issue bonds to investors in
order to raise capital. Each bond has a par value,
or face value, and is issued at a fixed or variable
interest rate; however, bonds often can be pur-
chased for less or more than their par value. This
means that the yield, or total return on a bond,
varies based on the price the investor pays for
the bond and its interest rate. Generally, the
more secure a bond is (i.e., the stronger the
assurance that the bond will be paid in full upon
maturity), the less the bond will yield to the
investor. Bonds that are not very secure invest-
ments tend to have higher returns. Junk bonds,
for example, are high-risk, high-yield bonds.
Except for the high-risk variety, bonds tend to be
relatively solid, predictable investments, with
prices that vary less than those of those of stocks
on the STOCK MARKET. As a result, litigation
because of unpaid bond agreements has rarely
proved necessary.
The most common type of bond is the sim-
ple bond. This bond is sold with a fixed interest
rate and is then redeemed at a set time. Several
varieties of simple bonds exist. Municipal gov-
ernments issue simple bonds to pay for public
projects such as schools, highways, or stadiums.
The U.S. Treasury issues simple bonds to finance
federal activities. Foreign governments issue
simple bonds, known as Yankee bonds, to U.S.
investors. Corporations issue simple bonds to
raise capital for modernization, expansion, and
operating expenses.
Conditional bonds do not involve capital
loans. Most of these bonds are obtained from
persons or corporations that promise to pay,
should they become liable. The payment is usu-
ally a nonrefundable fee or a percentage of the
face value of the bond. A bail bond is a common
type of conditional bond. The person who posts
a bail bond promises to pay the court a particu-
lar sum if the accused person fails to return to
court for further proceedings on the date speci-
fied. Once a bond payer satisfies the terms of a
conditional bond, the liability is discharged. If
the bond goes into default (i.e., if the obligations
specified are not met) the amount becomes
immediately due. Parties also can mutually
decide to cancel a conditional bond.
The emergence of simple government and
corporate bonds into the modern marketplace began with the economic boom of the 1920s.
Immediately after WORLD WAR I, the U.S. economy
rewarded investors who were eager to see
expansions in industrial growth. For most of the
1920s, until just before the Great Depression,
interest rates remained low. The bond market
became sophisticated enough to raise funds for
the U.S. Treasury, domestic corporations, and
foreign borrowers. It also proved useful during WORLD WAR II, when the federal government
depended on the sale of war bonds to finance its
military efforts.
During the 1980s, a different kind of boom
in the U.S. economy sent the bond market in a
more problematic direction. Even though highyielding
bonds tend to be less reliable investments
than low-yielding ones, the rapidly
increasing business activity in the 1980s led to
large-scale buying of these high-risk investments.
Corporations successfully bought out the
stock of other corporations by raising money
through the sale of millions of dollars of junk
bonds. (Junk bonds have been given low ratings
when measured by standard investment criteria—
hence the pejorative name.)
Troubles soon arose from the shaky foundation
of the JUNK BOND market. One of the country’s
leading figures in fostering junk bond
investments, Michael R. Milken, faced criminal
charges that he had manipulated bond prices,
traded on inside information, and bribed investment
managers. Milken’s image was further
complicated by his having worked with the stock
baron Ivan F. Boesky, who had been convicted of
insider trading. In April 1990, in Securities &
Exchange Commission v. Milken, 1990 WL
455346, Fed. Sec. L. Rep. ¶ 95,200 (S.D.N.Y.April
24, 1990), Milken pleaded guilty to six felonies,
including conspiracy, SECURITIES FRAUD, and
aiding and abetting the filing of a false document
with the SECURITIES AND EXCHANGE
COMMISSION. At the time of the initial settlement,
Milken agreed to pay $600 million in fines
and reparations. In November 1990, federal
judge Kimba M.Wood sentenced Milken to ten
years in prison. Milken served only two years of
his sentence behind bars.
Problems have also arisen with bonds issued
by governments. For example, when California’s
Orange County issued $169 million in municipal
bonds in June 1994, future taxes and other
general revenues were expected to pay for the
interest and principal of the bonds. But on
December 6, 1994, the county filed Chapter
Nine petitions in BANKRUPTCY court. The
county could not pay the bondholders, since the
money that had been set aside for them had
been depleted. By 1995, losses in the Orange
County investment pools approached $1.7 billion.
Representatives of the county found themselves
in court, being sued by the company that
represented investors. In In re County of Orange,
179 B.R. 185, 26 Bankr. Ct. Dec. 1050 (Bankr.
C.D. Cal. 1995), the bankruptcy court denied
bondholders’ claims to county revenues derived
after the Chapter Nine filing. The interests of
bondholders were seriously injured.
Nevertheless, bonds continue as popular
investments. Junk bonds, especially, have
regained favor as a means for earning considerable
returns. The relatively high interest rates of
junk bonds have entailed risks for buyers, but
Wall Street analysts have argued that the rewards
of these investment vehicles outweigh the dangers.
Indeed, the bond market in general has
even thrived in times of economic crisis.
FURTHER READINGS
Geisst, Charles R. 1992. Entrepot Capitalism. New York:
Praeger.
Platt, Harlan D. 1994. The First Junk Bond. New York:
Sharpe.
Wurman, Richard S. 1990. The Wall Street Journal Guide to
Understanding Money and Money Markets. New York:
Access Press.
Yago, Glenn. 1991. Junk Bonds. New York: Oxford Univ.
Press.
CROSS-REFERENCES
Securities.
Michael R. Milken: Genius, Villain, or Scapegoat?
Few business personalities have attracted as much
attention—both negative and positive—as bond
market financier Michael R. Milken. After earning an
estimated $1.1 billion in the 1980s as the head of Drexel
Burnham Lambert’s SECURITIES branch, Milken fell
from grace in the press and in the eyes of many
investors. In 1990 the Securities Exchange Commission
charged Milken with securities FRAUD. In U.S. district
court, Milken was fined $600 million, permanently
barred from engaging in the securities business, and
sentenced to ten years behind bars. Some of Milken’s
associates believed that he had been made a scapegoat;
Milken’s prosecution, they argued, was little
more than an attempt to pass judgment on the 1980s,
sometimes cast as the decade of greed.
Milken had formerly been heralded by the Wall
Street Journal as one of the century’s most important
financial thinkers. In the 1970s, after finishing studies
at the University of Pennsylvania’s Wharton Business
School, Milken was early in anticipating the boom of
the JUNK BOND market. He used his understanding of
trends in investment activity, along with innovative
approaches, to capitalize on what he called highreward
bonds. The junk bond boom led to both
Milken’s ascent and his incrimination. Milken’s correct
assessment of the junk bond boom paid off for
him. While he worked for the powerful Drexel Burnham
Lambert firm, his profits made him a billionaire.
But how he made those profits also led to his downfall.
The government held evidence implicating
Milken in manipulation of stocks, insider trading, and
BRIBERY of investment managers.
With fines and damages in civil lawsuits totaling
$1 billion, Milken became one of several news-making,
white-collar criminals of the 1980s. After his sentencing,
the Wall Street Journal retracted its praise
of the man, saying that “evidence now suggests that
Mr. Milken’s theory was wrong—and that he was far
from the genius he seemed to be about junk bonds.”
(National Review, August 31, 1992). Milken’s theory
held that the high yields of junk bonds would draw
investors to purchase many of them and that defaults
on these securities would be few. The intense corporate
competition of the 1980s waned; however, and in
later years, investors moved away from junk bonds in
search of other investment opportunities. Following
his release from prison, after serving two years of his
ten-year sentence, Milken was invited to lecture on
ethics in business at the University of California, Los
Angeles. To critics, however, Milken remained an
icon of the money-mad 1980s, a financial wizard
driven by the promise of vast wealth to push the limits
of SECURITIES LAW. The one-time billionaire
reemerged from prison with $300 million from his
days as the king of junk bonds, which he used entrepreneurially
in the education market, most notably as
the brainchild behind Knowledge Universe, a company
that owned several other education training and
consulting companies, including the popular
Leapfrog Enterprises (makers of LeapPad learning
aids). Additionally, Milken became more visible in his
philanthropic endeavors, particularly favoring prostate
cancer research and Milken creations such as
the Milken Family Foundation, the Milken Institute,
and Mike’s Math Club.
FURTHER READINGS
Bailey, Fenton. 1992. Fall from Grace: The Untold Story of
Michael Milken. Secaucus, N.J.: Carol Pub. Group.
Fischel, Daniel R. 1995. Payback: The Conspiracy to Destroy
Michael Milken and His Financial Revolution. New York:
HarperBusiness.
Platt, Harlan D. 2002. The First Junk Bond: A Story of Corporate
Boom and Bust. Washington, D.C.: Beard.
CROSS-REFERENCES
Investment; Stock; Stock Market.
