Lets say I buy a $1000 bond (loan?) for 80% of par value. The debtor is having a rough time and is having difficulty making interest payments and is distressed.
At the end of the bond’s term, would the owner of the bond get a principal pay back of $1000, $800 or would the lender and borrower work out some kind of principal payoff agreed upon by the two parties?
The bond pays $1000 when it matures, plus a final coupon interest payment. That’s what the bondholder gets unless the bond is in default or the compnay is in bankruptcy.
If the bond is in default and not yet at maturity, then there might be some kind of writedown (like Greece) or attempt to refinance and buy the bond back at whatever discount it’s currently paying. Or maybe the trustee accepts some company equity in exchange for a bond haircut on behalf of the bondholders (not 100% sure if it’s the trustee who negotiates that, but bondholders do occasionally get forced to take equity in exchange for a haircut).
If the company is in bankruptcy, the bond may be paid back in part. Presumably the 80% of par value is designed so that if default looks likely, you’ll still end up with more than 80% of par value recovered. If not, it’s a bad deal.
Figuring out how distressed bonds pay is a tricky situation, though, since a lot depends on the order of priority in payment, as well as how long the process takes. You might get 90% of your bond back, and approximatley a 10% return on your investment, but if the legal wrangling takes 10 years, that’s not going to give you an attractive rate of return or IRR.