Log out Go to App
Go to App

Learning Materials

Features

Discover

Chapter 2: Q.4 (page 96)

If you suspect that a company will go bankrupt next year, which would you rather hold, bonds issued by the company or equities issued by the company? Why?

Short Answer

Expert verified

It will be beneficial to have bonds rather than equities.

Step by step solution

01

Step 1. Introduction

A bond is a financial instrument that allows an investor to lend money to a borrower, such as a corporation or the government. The money is used to fund the borrower's operations, and the investor is paid interest on the investment. A bond's market value might fluctuate over time.

02

Step 2. Explanation

You're probably out of luck in both, but it's better to be in bonds because they have first preference on assets. When the company restructures, you might get something back on your bonds, but with equity, you're likely to earn nothing.

Unlock Step-by-Step Solutions & Ace Your Exams!

  • Full Textbook Solutions

    Get detailed explanations and key concepts

  • Unlimited Al creation

    Al flashcards, explanations, exams and more...

  • Ads-free access

    To over 500 millions flashcards

  • Money-back guarantee

    We refund you if you fail your exam.

Start your free trial

Over 30 million students worldwide already upgrade their learning with Vaia!

One App. One Place for Learning.

All the tools & learning materials you need for study success - in one app.

Get started for free

Most popular questions from this chapter

What is the difference between a mortgage and a mortgage-backed security?

If you are an employer, what kinds of moral hazard problems might you worry about with regard to your employees?

A significant number of European banks held large amounts of assets as mortgage-backed securities derived from the U.S. housing market, which crashed after 2006. How does this demonstrate both a benefit and a cost to the internationalization of financial markets?

Suppose you have just inherited \(10,400 and are considering the following options for investing the money to maximize your return:

Option 1: Put the money in an interest-bearing checking account that earns 3%. The FDIC insures the account against bank failure.

Option 2: Invest the money in a corporate bond with a stated return of 6%, although there is a 10% chance the company could go bankrupt.

Option 3: Loan the money to one of your friend’s roommates, Ayesha, at an agreed-upon interest rate of 7%, but you believe there is a 7% chance that she will leave town without repaying you.

Option 4: Hold the money in cash and earn zero return.

a. If you are risk-neutral (that is, neither seek out nor shy away from risk), which of the four options should you choose to maximize your expected return? (Hint: To calculate the expected return of an outcome, multiply the probability that an event will occur by the outcome of that event and then add them up.)

b. Assume that Option 3 and Option 4 are your only choices. If you could pay your friend \)50 to find out extra information about Ayesha that would indicate with certainty whether she will leave town without paying, would you pay the $50? What does this say about the value of better information regarding risk?

“In a world without information costs and transaction costs, financial intermediaries would not exist.” Is this statement true, false, or uncertain? Explain your answer.
See all solutions

What do you think about this solution?

We value your feedback to improve our textbook solutions.

Study anywhere. Anytime. Across all devices.

Sign-up for free