A bond that confers on the issuer the option to pay interest with additional pay-in-kind (PIK) debentures (baby bonds) rather than in cash. The paid-in-kind bonds are usually identical to the underlying bonds, but they often come with different maturities. This bond structure is primarily sought to relieve investors of rollover (reinvestment) risk. However, a debt issuer may essentially prefer to select to pay in kind to avoid using actual cash or at times it has cash flow problems. In this sense, pay-in-kind debentures are often used in order to reduce debt and finance operations, especially those related to leveraged buyouts (LBOs) and corporate restructurings.
Due to the risky nature of investing in such bonds, holders will expectedly receive a high yield compensating them for the additional risk involved. The issuer will exercise the option to pay in kind in the event interest rates move up, consequently making it harder or less attractive for the issuer to pay in cash.
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