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What is distressed debt?

Distressed debt is the loans and bonds of companies in financial trouble, in default or in bankruptcy, which usually trade far below their face value.

In practice

Distressed securities are below investment grade, which limits buyers mainly to hedge funds, private equity firms, investment banks and specialist funds. Investing in them means judging whether the company can carry on, where the debt sits in its capital structure and how much is likely to be recovered.

An example

Round numbers, not a real fund

Say a fund buys $10 million of a troubled company’s bonds for $4 million. If a restructuring pays 60 cents on the dollar, it gets $6 million, a $2 million gain; at 20 cents it gets $2 million and loses $2 million. Simple example. Terms vary by fund.

Why it matters

Buyers can earn large returns if the company recovers or pays out well in a restructuring, but the debt can also become worthless.

In practice

An example

Why it matters

In the news