Question

Which of the following statements concerning bonds are correct?

1) I. Bonds provide tax benefits to issuers.
2) II. The risk of a firm financially failing increases when the firm issues bonds.
3) III. Most long-term bond issues are referred to as unfunded debt.
4) IV. All bonds are treated equally in a bankruptcy proceeding.

Answer 1

Correct statements about bonds include that they provide tax benefits to issuers and increase a firm's financial risk due to higher debt obligations. Long-term bonds are not unfunded debt, and in a bankruptcy proceeding, not all bonds are treated equally.

Step-by-step explanation:

The discussion of bonds relates directly to the financial mechanisms and instruments used by firms for raising capital. With that focus in mind, let's address the statements:

1. Bonds provide tax benefits to issuers because interest payments on bonds are tax-deductible.
2. The risk of a firm financially failing does indeed increase when the firm issues bonds because it has increased its debt obligations. This risk, however, depends on the amount of debt relative to the firm's ability to pay.
3. Most long-term bond issues are not referred to as unfunded debt; this term typically applies to shorter-term obligations. Instead, they are part of the larger category of funded debt.
4. Not all bonds are treated equally in a bankruptcy proceeding; senior debts are typically paid before subordinated debts.

Additionally, in terms of investment strategy, a wise investor can mitigate risk associated with junk bonds by diversifying their bond portfolio across different companies.