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Chapter 8. Fixed Income Investments: Bui... > Bonds and Loss of Principal

Bonds and Loss of Principal

Regardless of how highly rated your bond may be, companies—even governments—have financial trouble and go out of business. Clearly, it is rare that a city or county government declares bankruptcy, but it has happened. In December 1994, Orange County in California filed for bankruptcy protection, having caved under the burden of $1.64 billion in losses on bonds that the county treasurer had purchased on margin with a bet that interest rates would not rise. When they rose by more than 3 percent, the county was not able to meet the margin call on the investment, and it filed for protection under the bankruptcy laws.

When companies file for bankruptcy, there is either a reorganization of the company or an orderly distribution of remaining assets. Bondholders stand in front of equity investors if a company goes out of business. If you have bought the bond of a company that goes bankrupt, you are likely to be represented by all bondholders and receive whatever negotiated settlement is due to the bondholders. There are different classes of bondholders, and those with the highest order of preference will be first to collect on any court-ordered distributions.


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