Consider the following statements:
Statement I: As regards returns from an investment in a company, generally, bondholders are considered to be at relatively lower risk than stockholders.
Statement II: Bondholders are lenders to a company, whereas stockholders are its owners.
Statement III: For repayment purposes, bondholders are prioritized over stockholders by a company.
Which one of the following is correct in respect of the above statements?
- A.Both Statement I and Statement II are correct and Statement II explains Statement I
- B.Both Statement I and Statement II are correct but Statement II does not explain Statement I
- C.Only one of the Statements II and III is correct and that explains Statement I
- D.Neither Statement II nor Statement III is correct
▶ Answer & Explanation
Correct answer: A. Both Statement I and Statement II are correct and Statement II explains Statement I
Bondholders, by lending money to a company, undertake a creditor relationship. In case of financial distress or liquidation, lenders (bondholders) have a prior claim on the company's assets over owners (stockholders). This hierarchical claim, combined with fixed interest payments which are often a contractual obligation, generally leads to lower risk for bondholders compared to stockholders, who receive dividends only after all other obligations are met and bear the residual risk of the company's performance.
Source: UPSC gs1 2025