This chapter discusses trading strategies involving distressed assets, including passive distressed investment strategies such as buying and holding distressed debt, and active distressed investing such as planning Chapter 11 reorganization of the company with an objective to obtain participation in the management of the company, attempt to increase its value and generate profits, buying outstanding debt with the view that after reorganization part of this debt will be converted into the firm’s equity, loan-to-own strategies, which amount to financing a distressed firm via secured loans, which upon reorganization will be converted into firm’s equity with control rights, strategies based on distress risk puzzle, whereby companies with low probability of bankruptcy tend to generate higher returns than riskier ones, including zero-cost healthy-minus-distressed strategies, which can be modified using risk management considerations to avoid significantly negative market beta following market downturns.
KeywordsDistressed assets Passive trading strategies Distressed debt Active distressed investing Chapter 11 Reorganization Firm’s equity Loan-to-own Secured loan Control rights Distress risk puzzle Bankruptcy Bankruptcy probability Healthy-minus-distressed Risk management Market beta Market downturn Financial distress Operational distress Debt seniority level Distress situation Explanatory variable Logistic regression Target volatility Risk premium
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