What are Distressed Securities?

Distressed securities are financial instruments of a company that are under price pressure due to bankruptcy (Chapter 7), reorganization (Chapter 11), financial turmoil, or other economic trauma.

How Do Distressed Securities Work?

Distressed securities can take the form of stocks, bonds, debt, or other financial instruments. These securities present opportunities for investors to purchase such assets at greatly reduced prices. Investors are willing to make high-risk investments in these types of securities since they assume that they know more than the creditors and have the patience to wait out the reorganization, or other cause of the distress. In the case of bankruptcy, investors (such as hedge funds, etc.) speculate that the liquidated assets are more valuable than the purchase price of the distressed securities.

Why Do Distressed Securities Matter?

Due to the high risks associated with investments in distressed securities, interested investors must be able and fit to participate successfully. First, they must have a better knowledge of the market than creditors (suppliers, vendors, etc.) in order to discern value at greatly reduced prices. Second, they must be able to tolerate a longer anticipated holding time than the creditors in order for these securities to bear fruit.

A wide range of investment funds are not allowed to hold distressed securities in their portfolios due to their risky nature. However, for funds which are allowed to invest in them, such as hedge funds, distressed securities offer special opportunities with lucrative returns.