Junk Bonds
Merrito, Inc., is a large U.S. firm that issued bonds several years ago. Its bond ratings declined over time and, about a year ago, the bonds were rated in the junk bond classification. Nevertheless, investors were buying the bonds in the secondary market because of the attractive yield they offered. Last week, Merrito defaulted on its bonds, and the prices of most other junk bonds declined abruptly on the same day. Explain why news of Merrito’s financial problems could cause the prices of junk bonds issued by other firms to decrease, even when those firms had no business relationships with Merrito. Explain why the prices of those junk bonds with less liquidity declined more than those with a high degree of liquidity.
Junk Bonds