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What are Distressed Securities?

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  • Written By: Malcolm Tatum
  • Edited By: Bronwyn Harris
  • Last Modified Date: 20 September 2016
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Distressed securities are financial instruments issued by a business that is either about to or is already involved in bankruptcy proceedings. Securities of this type may include bank debt, corporate bonds, trade claims and shares of stock issued by the company. These securities, which may involve any class of stock issued by the financially distressed business, are often available at a significant reduction in unit price.

Since the issuer is about to or is currently undergoing a Chapter 11 or Chapter 7 bankruptcy, the asking price for distressed securities is normally well below the market value commanded by those securities prior before the general public became aware of the current financial distress of the business. Assuming that investors project that the company will eventually emerge from the bankruptcy and become a profitable enterprise once more, purchasing the securities may be an excellent investment strategy. Should the company in fact overcome its financial woes and begin to grow again, the return on those distressed securities could be significant.

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In some countries, entering into a bankruptcy may render any shares of stock issued by the company seeking this level of protection totally worthless. When this is the case, investors may have no interest in the stock options at all. Here, the focus is on purchasing some type of senior security, such as the corporate bonds or the trade claims, since these securities are more likely to eventually yield some sort of profit. There is no specific time frame required for those acquired securities to begin recovering sufficiently to generate a return. It is not unusual for investors to buy the distressed securities and hold onto them for several years before actually realizing any type of benefit from the investment activity.

At the same time, purchasing distressed securities does involve assuming a great deal of risk. Many companies that do enter bankruptcy never emerge from that condition. Instead, the businesses may eventually be driven into liquidation, and be forced to sell off assets at a distressed sale. Unless a buyer steps forward to take control of the distressed company and that move is greeted with enthusiasm by industry experts and consumers, the purchased shares, bonds, or other forms of distressed securities may not even generate enough return to cover the reduced cost of purchase. While the potential return with these types of securities may be high, the degree of risk is also much greater than with many other types of investment opportunities, making it necessary for investors to consider the purchase of the securities very carefully before taking any action.

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