Consider the following statements: Statement I: As regards returns from an investment in a company, generally, bondholders are considered to be relatively at lower risk than stockholders. Statement II: Bondholders are lenders to a company whereas stockholders are its owners. Statement III: For repayment purpose, bondholders are prioritized over stockholders by a company. Which one of the following is correct in respect of the above statements?

1. A. Both Statement II and Statement III are correct and both of them explain Statement I
2. B. Both Statement I and Statement II are correct and Statement I explains Statement II
3. C. Only one of the Statements II and III is correct and that explains Statement I
4. D. Neither Statement II nor Statement III is correct

Answer: A

Explanation

Statement I is correct: Bondholders generally face lower risk than stockholders. Statement II is correct: Bondholders provide debt capital to a company, making them creditors or lenders, while stockholders purchase equity, making them part-owners of the company. This fundamental difference in their relationship with the company contributes to the risk differential. Statement III is correct: In the event of a company’s liquidation or bankruptcy, bondholders (creditors) have a higher claim on the company’s assets and are paid back before stockholders (owners). This prioritization significantly reduces the risk for bondholders compared to stockholders. Both statements II and III accurately describe the nature of bondholders and stockholders and their respective positions in a company’s capital structure, directly explaining why bondholders are at lower risk. Understanding financial instruments and investment risks is crucial for UPSC Economy.