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Wall Street's Newest Rave: Synthetic Junk Bonds

Thursday, 10 Mar 2011 09:16 AM

Low interest rates are sending investors looking for more riskier assets these days, including junk bonds, debt issued by less creditworthy companies. Yet there's a new investment out there these days, a derivative not unlike the ones tied to mortgages just prior to the financial meltdown.

Meet the synthetic junk bond, created by using credit derivatives on junk bond or high-yield indices, the Financial Times reports.

Synthetic junk bonds allow investors to take positions in the U.S. junk bond market — also known as the high-yield market — without owning the underlying securities.

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 Investors Seek Riskier Assets.
Rising demand for the instruments, especially among hedge funds, suggests investors feel that the U.S. economy is improving and corporate default risk is waning.

"We see much interest in synthetic high yield, more than we would have predicted just a few months ago," says Sivan Mahadevan, managing director at Morgan Stanley.

"With the Federal Reserve providing liquidity, default rates low and yields falling, the synthetic market is a way to increase returns," says an unnamed derivatives trader at another U.S. bank. "Investors are looking to take credit risk."

The exact level of activity of the derivatives is hard to gauge, the newspaper reports.

As a whole, junk bonds have rallied 88 percent since the end of 2008 and aren't done yet, says Anne Walsh of Guggenheim Partners, a financial-services firm overseeing $100 billion in assets, according to Bloomberg.

"We’re not falling into the bond-bubble thinking that a lot of the other investment management parts of the industry believe. We’re contrary to a lot of other investment managers in high-yield corporates as well as asset-backed securities."

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Low interest rates are sending investors looking for more riskier assets these days, including junk bonds, debt issued by less creditworthy companies. Yet there's a new investment out there these days, a derivative not unlike the ones tied to mortgages just prior to the...
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2011-16-10
Thursday, 10 Mar 2011 09:16 AM
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