Distressed securities

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Distressed securities are securities of companies that are either already in default, under bankruptcy protection, or in distress and heading toward such a condition.

The theory behind investing in these securities is that they often trade at discounts to a rational assessment of their risk-adjusted value for a variety of reasons. The psychological effect of a bankruptcy filing may lead to undervaluation, for example. Also, institutional investors often have policies that prevent them from investing in such circumstances, and that automatically means a lessening of demand for the instruments, which may again lead to undervaluation.

Distressed Securities have also been defined as securities, if not in default, that have a Yield to Maturity in excess of 600 to 800 basis points over the riskless rate of return.