Distressed Securities
Distressed securities are financial instruments issued by a company that is near to—or currently going through—bankruptcy. Distressed securities 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 (obligations incorporated into the debt or security, such as the ability 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 obligations, their financial instruments suffer a substantial reduction in value. However, because of the implicit riskiness of distressed securities, they can offer high-risk investors the potential for high returns.
Distressed Securities
Definition
Distressed securities are financial instruments issued by companies that are near bankruptcy or are already bankrupt. These securities can include common and preferred stocks, bank debt, trade claims, and corporate bonds. If a particular security fails to meet certain covenants (such as maintaining a specific debt-to-equity ratio or a certain credit rating), it can also be considered a distressed security. Due to the issuing company's inability to meet its financial obligations, the value of these financial instruments can drop significantly. However, because of the inherent risk, distressed securities can offer high returns for high-risk investors.
Origin
The concept of distressed securities originated in the 1980s when the high-yield bond market in the United States began to develop. As corporate bankruptcies and restructurings increased, investors started to focus on these high-risk, high-reward investment opportunities. Distressed securities gradually became a distinct investment category, attracting those willing to take on high risks for potentially high returns.
Categories and Characteristics
Distressed securities can be categorized into the following types:
- Common and Preferred Stocks: These are equity securities issued by companies, and holders may face significant losses in the event of bankruptcy.
- Bank Debt: This includes debt owed by companies to banks, which may not be fully repaid in the event of bankruptcy.
- Trade Claims: These are accounts receivable owed by the company to suppliers or customers, which may be reduced in the event of bankruptcy.
- Corporate Bonds: These are debt securities issued by companies, and holders may face partial or total losses in the event of bankruptcy.
The common characteristics of these securities are high risk and high return potential. Due to the financial distress of the issuing company, investors need to carefully assess its debt repayment ability and restructuring prospects.
Specific Cases
Case 1: Lehman Brothers
In 2008, Lehman Brothers filed for bankruptcy protection, and its various issued securities, including common stock, preferred stock, and corporate bonds, quickly devalued. However, some investors purchased these low-priced securities and sold them after the company's restructuring, achieving substantial returns.
Case 2: General Motors
In 2009, General Motors filed for bankruptcy protection, and its issued bonds and stocks significantly devalued. Some investors bought these distressed securities during the company's restructuring and achieved high returns after the company relisted.
Common Questions
1. Are distressed securities suitable for all investors?
No, distressed securities are mainly suitable for investors with a high risk tolerance. Beginners and risk-averse investors should approach with caution.
2. How to assess the investment value of distressed securities?
Investors need to carefully analyze the issuing company's financial condition, restructuring plans, and market prospects. The opinions of professional financial advisors and analysts are also crucial.
