Distressed Securities

Exploration Essay

Distressed securities are used by companies that are very close to or are currently going through bankruptcy. They can include common and preferred shares, bank debt, trade claims, and corporate bonds. A particular security can also be considered distressed if it fails to maintain certain covenants meaning they fail to maintain a certain asset to liability ratio, or a particular credit rating As a result of the issuing company's inability to meet its financial needs, its financial instruments suffer a huge loss in value. However, due to how risky distressed securities are, they can offer high-risk investors the potential for high returns. Distressed securities are liked by investors who are looking for a bargain and are willing to accept risk. In some cases, these investors believe the company's situation is not as bad as it looks, and as a result, they think that their investments will increase in value over time. In other cases, investors may predict the company going into bankruptcy, making them short of it. In many cases, the companies that issue distressed securities end up filing for Chapter 11 or Chapter 7 bankruptcy and as a result, people interested in investing in these securities need to consider what happens in the case of bankruptcy. In most bankruptcies, equity such as common shares become worthless. This makes investing in distressed stocks extremely risky. Furthermore, if a business files for Chapter 7 bankruptcy it will stop operations and go into liquidation. At this point, its funds are given to its investors such as bondholders. On the other hand, under Chapter 11 bankruptcy, a business restructures and continues operations. If this process is successful, its distressed securities, including both stocks and bonds, will give surprising amounts of profits.