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 purposes, 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
✅ Answer and Explanation
👉 Correct Option: [A] Both Statement II and Statement III are correct and both of them explain Statement I
- Statement I – Correct
Bondholders are at lower risk than stockholders because they receive fixed interest payments and repayment of principal, unlike shareholders whose returns depend on company performance. - Statement II – Correct
Bondholders = Lenders (creditors) of the company.
Stockholders = Owners (equity holders) of the company. - Statement III – Correct
In case of repayment or liquidation, bondholders have priority over stockholders. Equity capital is repaid only after debt obligations are fulfilled.
Thus, both II and III explain why bondholders carry less risk compared to stockholders.
Also See: Sources of Income of RBI: UPSC Prelims 2025 Question 2
📊 Bondholders vs Stockholders: A Detailed Comparison
| Feature | Bondholders (Creditors) | Stockholders (Owners) |
|---|---|---|
| Relationship with Company | Lenders (provide debt capital) | Owners (provide equity capital) |
| Return | Fixed interest (coupon) | Dividends (variable, not guaranteed) + Capital appreciation |
| Risk | Lower risk – fixed income + priority repayment | Higher risk – returns depend on profits; may lose entire investment |
| Priority in Bankruptcy | High priority; repaid before shareholders | Residual claim; last in line |
| Maturity | Bonds have fixed maturity date | No maturity date; shares can be held indefinitely |
| Voting Rights | Usually none | Have voting rights in company decisions |
| Income Nature | Predictable and contractual | Fluctuating and dependent on profits |
⚖️ Order of Payment in Bankruptcy
- Secured Creditors – Banks or lenders with collateral-backed loans.
- Preferential Creditors – Employees (wages), Government (tax dues).
- Unsecured Creditors – Suppliers, contractors without collateral.
- Bondholders – Repaid before equity but after secured creditors.
- Shareholders – Last to receive (only if anything remains).
📌 This explains why bondholders face lower risk while shareholders face higher risk but potential for higher returns.
Also See: Alternative Investment Funds
🧠 Mnemonic to Remember Bond vs Stock Differences
👉 “BOND = Borrower’s Obligation, Not Dividends”
- Bondholders → Borrower’s obligation (fixed interest, repayment assured).
- Stockholders → Dependent on dividends (uncertain, profit-linked).
🔎 Key Concepts for UPSC Aspirants
Why Bondholders Have Lower Risk
- Fixed contractual payments.
- Priority in repayment.
- Legal creditor status.
Why Stockholders Have Higher Risk
- Returns depend on company profits.
- Last priority in liquidation.
- Market price volatility.
But Why Stockholders Can Have Higher Returns?
- Unlimited upside potential (capital gains).
- Ownership rights (voting, dividends).
- Long-term wealth generation if company grows.
📝 Prelims Practice Questions
Q1. Consider the following:
- Bondholders are creditors of a company.
- Stockholders are guaranteed dividends every year.
- In case of bankruptcy, bondholders are repaid before stockholders.
Which of the above statements is/are correct?
[A] 1 and 2 only
[B] 1 and 3 only
[C] 2 and 3 only
[D] 1, 2 and 3
✅ Answer: [B] 1 and 3 only
Also See: Key Government Directorates under Department of Revenue
Q2. Which of the following best explains why bondholders are at lower risk than stockholders?
[A] Bondholders have ownership rights.
[B] Bondholders receive fixed returns and repayment priority.
[C] Bondholders participate in company’s profits.
[D] Bondholders can influence company decisions directly.
✅ Answer: [B] Bondholders receive fixed returns and repayment priority.
❓ FAQs
Q1. Why are bondholders prioritized over shareholders?
Because they are creditors with legal rights to repayment before equity owners.
Q2. Do shareholders always get dividends?
No. Dividends are discretionary, paid only when company has surplus profits.
Q3. Who faces higher volatility in returns – bondholders or shareholders?
Shareholders face higher volatility due to fluctuating market prices and profit dependency.
Q4. Which is better for long-term wealth creation?
Bonds → Safer, predictable returns, suitable for stability.
Stocks → Higher risk, but potential for high long-term returns.
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