The emergence of the junk bond as a financing tool contributed significantly to the merger and acquisition activity of the 1980s. Describe the junk bond and explain the premise on which its popularity grew. What was the inherent flaw in the rationale?

Junk bonds are high yield debt issued by risky companies. They were important in mergers because the debt load required to consummate many deals made the resulting firms risky. Junk bonds appealed to investors because they were pooled over a large number of issuing companies. The organizers claimed that high-risk firms failed only slightly more often than lower-risk companies. Therefore, a pool of bonds that yielded, say 15% after losing one or two percent to failures would still be more attractive to investors than a secure company's 10% bond. The flaw in the reasoning was that the failure rate of risky companies was only slightly higher than that of secure companies in good economic times. In bad times the rate was much higher. A recession in the late 1980s produced widespread failure among high-risk firms and led to major losses in junk bond portfolios. That led to a virtual collapse of the high yield segment of the bond market in the early 1990s.