Suppose a company decides to issue bonds at $1000 par value with $50 annual coupon (5% yield). Suppose these bonds were considered "investment grade" when issued. Suppose the company subsequently decides to engage in risky and questionable activities with the aim of making the bonds unattractive. The bonds are subsequently downgraded and become junk bonds. As a result of the junk status, investors on the secondary market demand an increased yield of 8%, so the bond sells for $625 ($50 ÷ 0.08 = $625) on the secondary market. The company, now having an opportunity to retire debt at a price lower than par, buys as many bonds as it can. For each retired bond, the company gains $375 ($1000 - $625 = $375) as a result of the downgrade to junk status. This benefits shareholders at the expense of the bondholders.
My concerns are:
- Can the situation above happen? Are companies able to deliberately cause a drop in bond prices in order to retire debt at a low cost?
- As a bond investor, how do I protect myself against such situations? The board of directors represents shareholders but not bondholders.