Q. Consider the following statements:
Statement I:
As regards returns from an investment in a company, generally, bondholders are considered to be relatively at lower risk than stockholders.
Statement II:
Bondholders are lenders to a company whereas stockholders are its owners.
Statement III:
For repayment purpose, bondholders are prioritized over stockholders by a company.
Which one of the following is correct in respect of the above statements?
(a) Both Statement II and Statement III are correct and both of them explain Statement I
(b) Both Statement I and Statement II are correct and Statement I explains Statement II
(c) Only one of the Statements II and III is correct and that explains Statement I
(d) Neither Statement II nor Statement III is correct
UPSC Prelims Question Paper 2025 Download Pdf
Answer & Explanation:
✅Correct Answer: (a) Both Statement II and Statement III are correct and both of them explain Statement I.
This question tests understanding of the financial relationship between bondholders and stockholders in a company.
Statement I says:
“Bondholders are considered to be at relatively lower risk than stockholders.”
This is correct. Bondholders lend money to a company and receive fixed interest payments. Their investment is generally considered safer because they are paid back before stockholders in the event of liquidation. Stockholders, on the other hand, are residual claimants — they are paid only after all liabilities are cleared. Thus, their returns are more uncertain, and they bear higher risk.
Statement II says:
“Bondholders are lenders to a company whereas stockholders are its owners.”
This is also correct. Bondholders are creditors who lend money and are entitled to regular interest payments and principal repayment. They have no ownership in the company. Stockholders, or shareholders, are the owners of the company. They may receive dividends from profits but have no guarantee of fixed returns. They also have voting rights and a claim on residual assets.
Statement III says:
“For repayment purpose, bondholders are prioritized over stockholders by a company.”
This is again correct. In both regular financial operations and in bankruptcy proceedings, companies are legally required to repay debts (including bondholders) before returning any funds to shareholders. This repayment priority further explains why bondholders face less risk.
Now let’s evaluate the options:
- Option (a): Both Statement II and III are correct and they explain Statement I. This is true — II and III justify why bondholders are at lower risk.
- Option (b): Statement I and II are correct, but I doesn’t explain II.
- Option (c): Incorrect — both II and III are correct, not just one.
- Option (d): Incorrect — both II and III are correct.
✅ Correct Answer: (a)
Both Statement II and Statement III are correct and both of them explain Statement I.