Question

Four years ago, Sam invested in Grath Oil. Use the scenario above to select the best answer. a. It is equally likely that the company would suspend paying interest on the bonds and dividends on the stock. b. Both the coupon rate and the dividend rate are fixed and cannot change. c. The bonds showed a higher percentage return than that of the stocks. d. The amount of money received annually in interest (on the bonds) and in dividends (on the stocks) depends on the current market prices.

Answer 1

The coupon rate on bonds is usually fixed, while dividend payments on stocks can fluctuate and are not guaranteed. The amount of money received from bonds and stocks depends on different factors, with interest on bonds being generally more stable than dividends from stocks. Historical averages suggest that stocks offer higher returns than bonds, reflecting their higher risk.

Step-by-step explanation:

Considering the scenario provided regarding Sam's investment in Grath Oil, the best answer to whether it is more likely that the company would suspend paying interest on the bonds or dividends on the stock is not clear without more information. Typically, the bonds would have a fixed coupon rate and companies are obliged to pay bond interest before any dividends on stocks. Therefore, stocks are often considered riskier investments. The statement about the coupon rate and dividend rate being fixed is only partially correct; while the coupon rate on bonds is generally fixed, dividend rates on stocks can vary depending on the company's performance and decisions by the board of directors.

The rate of return for bonds typically depends on their coupon rate and market price, which can fluctuate with interest rates, while stock returns include dividends plus capital gains, which can be much more volatile. Over time, stocks have historically provided higher returns than bonds, but with greater risk and volatility. Therefore, the amount of money received in interest on bonds is more stable compared to dividends from stocks, which can change and are not solely dependent on the market price of the stock.

As for the percentage return of bonds versus stocks, it cannot be universally claimed that bonds showed a higher percentage return without specific data. However, as per historical averages, stocks typically offer higher returns relative to bonds but with increased risk.

Answer 2

Option d, which states that the amount of money received annually from interest and dividends depends on the current market prices, is the more accurate statement for stocks and partially accurate for bonds, as interest on bonds is fixed but dividends on stocks can vary.

Step-by-step explanation:

Understanding Investment Returns

When Sam invested in Grath Oil four years ago, the future of his investments would depend on various factors, including the performance of the company and market conditions. For bond investments, interest payments, known as coupon rates, are typically fixed and would not depend on the current market prices of the bonds. This means that option b, stating 'Both the coupon rate and the dividend rate are fixed and cannot change', would be incorrect as dividend rates can vary. Stocks, unlike bonds, do not have guaranteed returns and can yield dividends and capital gains, both of which depend on the company's performance and market conditions. Given that, option d, suggesting that the amount of money received annually in interest and dividends depends on current market prices, can be considered more accurate for stocks but not for bonds.

The likelihood of the company suspending interest or dividends, as stated in option a, would depend on the company's financial health and is not necessarily equally likely. Regarding option c, asserting that 'The bonds showed a higher percentage return than that of the stocks', this cannot be determined without specific return data. Generally speaking, over a long period, stocks tend to offer higher returns than bonds, compensating for their higher risk.

Ultimately, the best answer for this scenario is option d: The amount of money received annually in interest (on the bonds) and in dividends (on the stocks) depends on the current market prices, as it is true for stocks but not for bonds where interest payments are predetermined.