Final answer:
Subordinate bonds and preferred stock are riskier than long-term senior bonds due to their lower priority in repayment order, which means they are less likely to recover investments in the event of a company's financial distress. They may offer higher returns but with increased uncertainty and risk.
Step-by-step explanation:
The question asks why subordinate bonds and preferred stock are considered more risky compared to long-term senior bonds. The correct answer is that they have higher priority in repayment. This means that in the event of a company's liquidation or bankruptcy, holders of long-term senior bonds will be paid out before those holding subordinate bonds or preferred stock. Additionally, because preferred stock is an equity instrument, it does not offer as predictable a return as debt instruments like bonds do.
While subordinate bonds and preferred stocks may offer higher potential returns to compensate for increased risk, their payouts are less certain, and if a company falls into financial distress, they are less likely to recover their investment compared to senior bondholders. Furthermore, certain preferred stocks may come with more exposure to market fluctuations, similar to common stocks.