Identification

• Companies with distressed debt are companies that have either filed for bankruptcy or are very likely to file for bankruptcy. Some investment firms and hedge funds not only invest money but also provide the bankrupt company with advice regarding the resolution of debt, according to Investopedia. Helping out the distressed debtor can increase the chances that the investors make a profit.
  
  

Features

• Two dominant features of distressed debt are operating volatility and financial leverage. Operating volatility comes from factors such as economic cycles, issues with employee compensation, natural disasters, political strife, changes in technology, changing consumer tastes and factors specific to the particular industry that the company is in such as the effects of government policies on the health care industry, according to Kelly DePonte of Probitas Partners writing for Private Equity International. The other situation—financial leverage—involves financial obligations that the company has to others—such as vendors—but does not have the finances to pay, which can lead to mounting fees resulting from delayed payments.
  
  

Benefits

• Since distressed debt is very risky, there is a chance for greater returns if the distressed company does well, since the distressed debt sells at a low percentage and can be sold at a much higher profit if the company does well, according to Investopedia.
  
  

Hedge Fund

• Hedge funds are investments that are more aggressive and use advanced investment techniques with the hopes of bringing about higher investment returns. Distressed debt is often taken on by hedge funds, according to Investopedia.
  
  

Sources

• Hedge funds and other institutional investors acquire distressed debt in several ways. The bond market is the easiest source because a large supply of debt is available easily soon after a default. Mutual funds are not allowed to own securities that have defaulted and so are a good source of distressed debt, according to Investopedia. Investors can also deal directly with distressed firms by extending them credit when they need it the most.
  
  

Potential

• Distressed debt is often purchased when the investor thinks that the securities are mispriced and will rebound. To make this prediction, the investor must have knowledge of the marketplace in which the securities are traded, according to Kelly DePonte.