Question

If you were a bondholder lending to a firm and you were worried that stockholders would take advantage of you, which of the following actions would concern you the most? (Pick only one)

i.

ii. .

iii.

iv.

v.

a.

A cut in the dividends paid to stockholders

b.

A reduction in debt

c.

A new stock issue

d.

Expansion into a risky new business

e.

Accumulation of cash in the company

Answer 1

A cut in dividends is a good thing as the company is retaining the earnings. A reduction in debt means the company has enough money to repay. A new stock issue will not affect a debtholder as they are paid before bond holders. Accumulation of cash is not an issue till the company is making payments to bondholders. But, if the company takes up a risky business, it can be at a risk of default which is a cause of concern for a debtholder. Hence, the correct option is-

D. Expansion into a risky new business.

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