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What is Distressed Debt?

by Alan Daniel
What is Distressed Debt?

Asset prices continue to grow. Markets are bullish despite waves of initial public offerings by unprofitable companies. Some experts believe that there’s a “top” in the financial markets. Distressed debt investors are waiting patiently to capitalize on a market correction.

But what is a distressed debt?

When it comes to riskier investments that offer high returns, distressed debt often rank in the top few instruments available in modern business markets.

The reasons for this are quite simple.

First, even while being a high risk financing opportunity, distressed debt instruments are somewhat easily available. Second, distressed debt could be bought at a fraction of its original price. And third, it could be purchased in a way that provides maximum profits with minimal risk (if done right).

To understand what is distressed debt and how you can take advantage of it, here are a few pointers to comprehend this asset class quickly.

What is Distressed Debt and Why Should You Care?

Distressed debt refers to bonds sold by a business that is under distress. In other words, these are bonds sold by a business that is going under any deep financial or operational issues. These businesses could simply be under distress, could be defaulters on their financial commitments, or going through bankruptcy.

Now, your next question might be, why someone would want to buy bonds from a company that is headed to a financial abyss?

The answer: business is full of uncertainties. But to come out on top, you should be willing to take calculated risks.

Distressed debt could offer the rare chance for your investment to grow in a significant manner, with a little bit of work. Understanding stocks, bonds and under-performing businesses could be an exhausting experience. But once you comprehend what is distressed debt and where to purchase it, it might be very easy to take advantage of this investment process.

Distressed Debt is Available Through Different Avenues

Distressed debt bonds could be purchased through different markets.

One of the easiest ways is to purchase distressed debt via the bond market. Usually, distressed debt bonds are available in the market shortly after a business has gone under its own expectations. Unlike mutual funds that come with a lot of regulations, bond markets offer distressed debt quite openly, where these assets often sell quickly and often.

Another popular way to purchase distressed debt is directly via the issuer of the bond. Instead of searching through the bond market to find a suitable match, reach out to specific firms in the sector who are going through distress or bankruptcy. If they are selling their bonds, then you can easily get your hands on this low-cost/high risk investment opportunity.

How to Benefit From Distressed Debt

Now that you understand what is distressed debt, it is time to understand how you can benefit from this particular offering.

Distressed debt bonds are sold at a very cheap price by their respective companies. It is because the company is going through a difficult time, with no knowledge about when it will recover. For all you know, it might never be able to bounce back. This risk is why the bonds issued by these companies go out on a lower price.

But if a company can and does pull through to get back on its feet, then the bond could be sold and transferred to another party for a higher price.

That is why those who are looking to benefit from larger gains against a lower cost often turn towards distressed debt.

Hedge funds and private equity firms may purchase distressed debt in large quantities to take over the company and restructure it for maximum gains. Private equity firms and others usually sit and wait with cash to swoop in when markets have crashed. They get access and control of these distressed firms and seize the opportunity.

But it is important that when you invest in distressed debt, you do so after immense consideration.

This way, if a company doesn’t recover from its dismal state, then you don’t have to sustain all the damage. By diversifying your investments across different assets, you could benefit from the power of two instead of one.

Another thing to keep in mind is to ensure that your distressed debt agreements or indentures are fully laid out in an understandable manner. These documents are what define the value of your specific investment, so ensure to take the help of a lawyer and see if the debt agreement is to your advantage.

By studying market conditions and your requirements, you can make use of the opportunities offered by distressed debts, while also steering away from unnecessary high risk.

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