Question

5. In ranking from least potential cash flow risk to highest potential risk for the issuing firm the following order is appropriate
a. Corporate Bonds, Common Stock, Preferred Stock
b. Preferred Stock, Common Stock, Corporate Bonds
c. Common Stock, Preferred Stock, Corporate Bonds
d. Corporate Bonds, Preferred Stock, Common Stock

Answer 1

The correct answer is option c

c. Common Stock, Preferred Stock, Corporate Bonds

From the perspective of the issuing firm, common stock is the least potential cash flow risk because the firm has no obligation to pay dividends to the common stock holders.

The next risky instrument is the preferred stock. The firm has an obligation to meet the regular dividend payments to the preferred stock holders.

But, the firm must pay interest payments to the corporate bond holders regardless of whether the company makes profit or not. So, corporate bonds poses the highest cash flow risk to the issuing firm.