Question

What are some differences in the income received by common stockholders and the income received by bondholders?

O Dividends are not fixed, but interest is generally a fixed dollar amount.

O Common stock pays dividends while bonds pay interest.

O Both dividends and interest income are guaranteed as long as the corporation is generating sufficient income.

O Dividends are not based on the par value of stock, but interest is generally based on a bond's par value.

Answer 1

Common stockholders receive dividends which are variable and dependent on company profits, while bondholders earn fixed interest income based on a bond's par value. Dividends are not guaranteed and are based on the number of shares held, whereas bond interest is a legal obligation that the firm agrees to pay, potentially enforceable through court action.

Step-by-step explanation:

Common stockholders and bondholders receive different types of income based on their investment in a corporation. The income received by common stockholders is typically through dividends, which are not fixed and depend on the company's profitability. The more shares a person owns, the more they are entitled to receive when dividends are declared. For example, companies like Coca-Cola may offer dividends to their shareholders, incentivizing them to hold onto their stock for an extended period.

Bondholders, on the other hand, receive income through interest payments. When a corporation issues bonds, it borrows money from investors and agrees to pay a fixed interest rate, known as a coupon rate. This interest income is generally a fixed dollar amount and is based on the bond's par value. Even if a company underperforms, bondholders still have a legal claim to their interest payments and can take the firm to court if those payments are not made.

Contrary to some misconceptions, neither dividends nor interest income are guaranteed. Dividends are paid at the discretion of the corporation and can be adjusted or omitted depending on its financial performance. In contrast, interest on bonds must be paid as per the terms of the bond agreement. However, in cases of financial distress, a corporation may default on bond payments. At such times, bondholders may not recover the full amount loaned to the firm.

Answer 2

Common stockholders receive dividends which are variable and not guaranteed, while bondholders receive fixed interest payments. Dividends depend on company's profits and are not obligated, unlike bond interest payments which are contractual. Options 1 and 2 are the correct answer.

Step-by-step explanation:

The income received by common stockholders mainly comes from dividends, which are not guaranteed and vary depending on the company's profitability. Dividends are directly related to the number of shares owned, and companies may decide to pay more, less, or no dividends at various times. On the other hand, the income received by bondholders is in the form of interest, or coupon payments, which are generally fixed sums based on the bond's par value. Unlike dividends, these interest payments are typically contractual obligations and must be paid before any dividends can be distributed. Furthermore, while bondholders have a right to seek repayment in court if the firm defaults, common shareholders are last in line in claims on a firm's assets.

Given these differences, bondholder payments are generally considered to be more stable and predictable than the income from common stock dividends. However, stocks may offer potential for capital gains which can make them attractive for different investment strategies such as diversification.

Therefore, the statement 'Dividends are not fixed, but interest is generally a fixed dollar amount.' and 'Common stock pays dividends while bonds pay interest.' accurately describe key differences in the income received by common stockholders versus bondholders.