What is ‘Bad Paper’
Unsecured short-term fixed income instrument that is issued either by a corporation, city, state or country, that has a high probability of defaulting on their promissory notes. Since bad paper is not backed by collateral, it is sold at a discount to the equivalent collateral-backed fixed-income securities. However, in contrast to regular commercial paper which typically has a strong rating from a credit agency, bad paper does not possess this quality.
Explaining ‘Bad Paper’
Bad paper is risky. Not only is it not backed by collateral, it is also issued by an entity that could potentially fail to meets its obligations. Bad-paper investors take on high levels of risk and, as a result, would be offered an attractive interest rate as proper compensation.
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