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Introduction to Distressed Financing Bonds



 

Introduction


As you explore the various options to diversify your investment portfolio, you must have stumbled upon some debt investment schemes. If you are considering investing in a debt investment instrument with very low risk and guaranteed returns, distressed financing bonds can be a good option. Financial institutions issue distressed financing bonds to raise funds to finance companies that are going through insolvency, also known as the Corporate Insolvency Resolution Process or CIRP. On purchase of these bonds, investors receive as high as 14% returns which are very lucrative when compared to other fixed-income instruments.


What are Distressed Financing Bonds?


Distressed financing bonds are bonds issued by financial institutions to help companies undergoing insolvency meet their CIRP expenses. Typically, these financial institutions are NBFCs (Non-Banking Financial institutions) that cater to issuing these bonds.

By purchasing these bonds, an investor is lending a specific amount of sum to a company that is going through insolvency. LegalPay ensures that the company has high asset coverage.

Is it safe to invest in distressed financing bonds?


The most important thing when an investor invests in a bond boils down to the safety of the capital invested and the surety of returns on the bonds after considering this dire need of the investor, distressed financing bonds are structured in a way it gets top most priority in repayment of capital even if the company goes into liquidation, according to the waterfall mechanism in Insolvency and Bankruptcy Code (IBC) 2016 thus making it a super-senior product and assuring a safety net for the investors. Also, as these bonds are callable bonds, meaning if the company undergoing insolvency repays the amount to the financial institution before the tenure, the financial institution will call back the bonds and return the principal as well as interest accrued on those bonds to the investors which mean the invested amount can be repaid before the tenure.

Why does the price of the bonds keep on increasing each day?


It is due to the fact that the bonds are listed at a dirty price rather than the clean price. The clean price is the price of a coupon bond not including any accrued interest. A dirty price is the price of a bond that includes accrued interest and the face value.

So, in this case, when a bond lists on a platform, the interest starts getting accrued on the bond from the first day of issuance and the investor has to pay the complete amount including accrued interest and the face value.

Who should an investor invest in Distressed financing bonds?


Bonds are considered a safe instrument to invest and any investor who is looking to invest in a credit risk-free asset should definitely consider these bonds. Also, it is preferred to allocate a certain portion of your portfolio to a fixed-income instrument to provide a safety net for your financial well-being.


Following is the table of different types of bonds with their coupon rate and associated risks -



Type of Bonds

Average Coupon Rate

Risk

Government Security Bonds

6%-7.5%

Low

Sovereign Gold Bonds

2.5% + Capital Gains

Low

Municipal Bonds

7%-8.5%

Medium

Corporate Bonds

8%-10%

High

Distressed Financing Bonds

14%

Medium


From the table, it can be inferred that distressed financing bonds are providing high returns on invested funds with a comparatively lower risk making it a lucrative opportunity to invest in.


In conclusion, distressed financing bonds are a safe investment and are not exposed to market volatility. An investor can invest in them if they want a debt component in their portfolio with high returns and wants to diversify their overall portfolio.

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