Trading Strategies for Distressed Debt
If you are interested in working for a hedge fund or other financial institution that trades distressed debt on a regular basis, it is important to understand what distressed debt is and the reasons for trading. Distressed debt is made up of securities from companies or government organizations that are already in bankruptcy, in distress or heading in that direction. Financial institutions will sometimes purchase this debt in hopes of turning it around and making a profit.
Other People Are Reading
-
Capital Trading Strategy
-
Companies that have distressed debt are usually in a position where few options exist for them. As a result, some distressed debt traders will seek out companies with distressed debt and offer them high-priced capital to help them pay their bills and continue until a rebound strategy presents itself. By offering capital at high interest rates, traders can make a hefty sum of money on these trades.
Basic Trading Strategy
-
While some traders only deal with the first section, others trade in a more basic sense — they purchase distressed debt at a low price and attempt to sell it quickly for a profit. Traders must do in-depth analysis of a company's financials and determine what, if any, extraneous factors could affect the distressed debt. From there, they must make a decision as to whether or not they would like to purchase it. Because of the ever-changing situations of companies with distressed debt, the financial picture of an organization can look much better even days or weeks after a trader makes a purchase. The typical holding period for trades with this strategy is anywhere from two days to three weeks.
-
Active/Non-Control Trading
-
Active/non-control trading refers to a strategy where traders will purchase significant, and usually controlling, portions of distressed debt fro companies that are going through or are likely will be in the future going through a restructuring process. By holding significant positions in the company during this time, these traders can influence the decision-making process of rebuilding the company in hopes of reaping high profits once the organization has made a full recovery.
Chapter 11 Bankruptcy Trading
-
Using this strategy, traders will purchase debt while a company is in Chapter 11 bankruptcy in hopes of reselling the debt at a higher price once the company has rebounded. While similar to the active/non-control model, the strategy is fundamentally different; by purchasing debt while a company is in Chapter 11 bankruptcy, a trader is buying the distressed debt at the lowest possible price, but at the same time buying when the risk is at it's highest. This yields the highest possible return for traders, but it also extremely risky at the same time.
-
