Distressed Securities

Definition

Distressed securities are financial instruments, such as bonds, stocks, or bank debt, of companies that are either close to or in bankruptcy, or dealing with major financial distress. These securities are often sold at a significant discount due to the high risk associated with the issuer’s financial instability. Investors who buy distressed securities gamble on the chance that the issuer’s situation will improve enough to allow them to sell the securities at a profit.

Phonetic

The phonetics of the keyword “Distressed Securities” is: dih-strest si-kyoor-i-tees

Key Takeaways

1. High-Risk High-Return Investments: Distressed Securities are often labelled as high-risk investments because they represent companies that are in financial or legal distress. However, if the companies manage to turn around their situation, these securities can potentially provide very high returns to their investors.
2. Specialized Knowledge Required: Investing in Distressed Securities requires a thorough and specialized knowledge of the company’s industry, as well as the reasons behind its current distressed situation. It also requires an understanding of bankruptcy laws and the process of financial restructuring.
3. Significant Role of Market Conditions: The performance of Distressed Securities is heavily influenced by market conditions. They’re more likely to provide high returns during market turnarounds or in a bullish market. Conversely, they can also lead to significant losses in a bearish market or during an economic recession.

Importance

Distressed securities are crucial in the world of business and finance due to the significant investment opportunities they present. These are securities of firms that are in financial difficulty and are either undergoing or on the brink of bankruptcy. Despite their associated high risk, distressed securities can yield considerable returns for investors capable of accurately assessing and managing this risk. Buying these securities at heavy discounts during a company’s restructuring phase often leads to substantial returns if the company manages to improve its financial health. As a result, distressed securities attract various market participants like hedge funds or private equity firms, playing a significant role in restructuring and impacting the overall market performance.

Explanation

Distressed securities are financial instruments issued by companies that are near or are currently undergoing bankruptcy. These securities often include bonds, debits, and equity with dramatically reduced values due to the issuer’s inability to meet its financial obligations. Though seen as high risk investments, distressed securities serve a significant purpose in the world of finance.Investors who specialize in distressed securities often play a role in a company’s recovery or in the restructuring process if the company is in bankruptcy. These investors buy the securities at a major discount with the assumption that the company in distress will manage to survive, and these securities will rebound in value. On the other hand, if the company does go under, the investors could still possibly recover a portion of their investment during the liquidation processes. Thus, distressed securities serve as a tool for investment, aiding in both financial recovery and portfolio diversification.

Examples

1. Lehman Brothers Holdings Inc: During the 2008 financial crisis, Lehman Brothers filed for the largest bankruptcy in the U.S history. Its securities turned distressed as the company wasn’t able to meet its debt obligations due to exposure to depreciated real estate assets. Numerous institutional investors were left holding distressed securities that dropped significantly in value. 2. Toys “R” Us Inc: In 2017, the well-known toy retailer filed for bankruptcy after struggling with a heavy debt load and intense competition from online retailers. Prior to its bankruptcy, Toys “R” Us had issued bonds to raise business capital. These bonds became distressed securities after the company announced bankruptcy, but some hedge funds and private equity firms purchased these distressed bonds with hopes that they might recover some value during the company’s restructuring process. 3. Argentina’s Sovereign Debt: Argentina defaulted on its sovereign debt in 2001 and again in 2014. During these periods, Argentina’s bonds were seen as distressed securities because the government wasn’t able to fulfill its debt obligations. However, a few asset managers bought these bonds at a substantially discounted price, betting on Argentina’s ability to eventually repay at least a portion of the debt.

Frequently Asked Questions(FAQ)

Related Finance Terms

• Default Risk
• Bankruptcy
• Recovery Rate
• Debt Restructuring
• Junk bonds

Sources for More Information

• Investopedia
• Wikipedia
• Nasdaq
• Corporate Finance Institute