Hedge funds often have the ability to produce a high rate of return on an investment very quickly, but they can also go into financial crises in that same amount of time. One type of investment that can produce such a diverse return is distressed debt. Distressed debt is defined as the debt of companies that have filed for bankruptcy or have a significant chance of filing for bankruptcy in the near future.
The benefit of investing in something with such a high likelihood of defaulting is as follows: the more risk you take on, the more reward you can possibly make. The other incentive of distressed debt is that it sells at a very low percentage of par value. If the company that was once “distressed” is able to emerge from bankruptcy and become a viable firm, the distressed debt will have a much higher value on the market and therefore sell at a much higher price. The return on the small investment will be very large for the investor; however, the companies that are often offering distressed debt tend to default.
The same attributes that attract hedge funds also incline individual investors with the same idea. It is highly unlikely that an individual would take on an active role with a company the same way that a hedge fund would, but there is still plenty of potential ways for a regular investor to reap the benefits of distressed debt. The market of distressed debt definitely has its ups and downs, although hedge funds and sophisticated individual investors have high returns to gain from the high risks that they are taking. If a hedge fun or investor can control the risks, both can earn great rewards are paid handsomely for navigating through a firm’s tough times.
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