Part 1Which of the following are differences between a bond and a common stock? (Select all that apply.) A. A bond is a claim on the earnings and assets of a corporation, whereas a common stock promises to make periodic payments for a specified period of time. B. A corporation has to pay all bondholders before paying stockholders. C. A corporation has to pay all stockholders before paying bondholders. D. A bond is a debt instrument that entitles the owner to receive periodic amounts of money until its maturity date, whereas a common stock represents a share of ownership of the institution that has issued the stock.

Question

Part 1Which of the following are differences between a bond and a common​ stock? ​(Select all that​ apply.) A. A bond is a claim on the earnings and assets of a​ corporation, whereas a common stock promises to make periodic payments for a specified period of time. B. A corporation has to pay all bondholders before paying stockholders. C. A corporation has to pay all stockholders before paying bondholders. D. A bond is a debt instrument that entitles the owner to receive periodic amounts of money until its maturity​ date, whereas a common stock represents a share of ownership of the institution that has issued the stock.

BlackTom AI · Accepted Answer

To approach this question, I will compare each statement to fundamental concepts about bonds and common stock, highlighting how they differ in terms of claims, payments, and ownership.
Option A: 'A bond is a claim on the earnings and assets of a corporation, whereas a common stock promises to make periodic payments for a specified period of time.' This is inaccurate. A bond is primarily a creditor claim on a company’s assets and future cash flows, but it does not entitle the holder to a share of earnings as stock does; instead, bondholders receive fixed interest payments (coupons) and a return of principal, not a promise of earnings. The description of stock as promising periodic payments for a specified period also misstates stock characteristics, since common stock typically pays dividends (which are not guaranteed and depend on profits and decisions by the board) and does not have a maturity or fixed payment schedule like a bond.
Option B: 'A corporation has to pay all bondholders before paying stockholders.' This statement captures a key priority difference. In a corporate structure, debt holders (bondholders) have a higher claim on assets and earnings than equity holders (stockholders). In liquidation, bondholders are paid before shareholders; and in the normal course, interest payments to debt holders take priority over any dividends to stockholders. Therefore, this option correctly identifies a fundamental difference in claims and payments order.
Option C: 'A corporation has to pay all stockholders before paying bondholders.' This is incorrect for the opposite reason: it suggests stockholders are prioritized over debt, which is not true in standard corporate finance. Debt holders have senior claims, and dividends to stockholders are discretionary and typically come after debt obligations. So, this statement reverses the actual priority structure.
Option D: 'A bond is a debt instrument that entitles the owner to receive periodic amounts of money until its maturity date, whereas a common stock represents a share of ownership of the institution that has issued the stock.' This accurately contrasts the two instruments. Bonds are promises by the issuer to pay fixed (or scheduled) interest and repay principal at maturity, reflecting a debt relationship. Common stock represents ownership in the issuing company, with potential dividends and residual claims after debt is satisfied, and it does not have a fixed maturity. This option correctly states the core structural difference between a bond and a share of stock.
In summary, Option A mischaracterizes the payment structure and the nature of stock versus bond payments; Option C wrongly asserts that stock is paid before bondholders; Options B and D correctly describe the priority of claims and the fundamental nature of bonds as debt versus stock as ownership. The correct selections, therefore, are B and D, with A and C being incorrect interpretations of these financial instruments.

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Quiz:Quiz 1

View Explanation

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Similar Questions

Which of the following is not a reason that a company would want to issue bonds (debt) instead of stock?

The incentives of equity investors and lenders are well aligned in that both care about improving firms’ long-term value.

Which of the following is NOT debt security?

________ is a contractual obligation to pay back the amount that has been borrowed. The borrower owes principal and interest to the lender. Whereas_____ provides ownership of the company to the shareholders.

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