Bad Paper

Bad paper is an unsecured (no collateral) short-term fixed income instrument (bond) that is issued either by a corporation, city, state, or country, that has a high probability of defaulting on its promissory notes. Bad paper equals junk bonds. Junk bonds are...risky.

Here's the deal: The entity issuing those bonds is trying to keep the metaphorical sinking ship afloat. The entity needs cash. Issuing the bonds produces the cash to the issuer promising to pay back the dough eventually. However, because of the entity's ill financial health, the bonds must be issued at a deep discount, and/or at a very high interest rate. A speculative investor might still buy the bad paper (again, junk bonds), because if the issuer can turn it around, the investment could bring significant profits and above-average interest payments to investors.

A good example: Puerto Rico bonds. For a long time, Puerto Rico bonds were viewed as losers, as the island was near default and hit hard by the hurricanes in the fall of 2017. However, recent headlines (from March 2018) state "Puerto Rico forecasts $6 billion surplus as bonds soar," reflecting the unexpected improvement in the island's economy, as well as hopes for Puerto Rico to resolve its continuing bankruptcy problems.