Correct Option
Statement I is correct. Bondholders are considered to be at a lower risk than stockholders because they have a contractual right to receive fixed interest payments and the repayment of their principal amount, irrespective of the company's profitability (subject to its solvency). Stockholders, as owners, have a residual claim on the company's earnings and assets, which makes their returns more volatile and dependent on the company's performance.
Statement II is correct. Bondholders provide debt capital to a company, thereby acting as its creditors or lenders. They do not hold ownership stakes. Stockholders, conversely, provide equity capital and represent the ownership of the company, holding claims on its assets and earnings after all liabilities are settled.
Statement III is correct. In the event of a company's liquidation or bankruptcy, bondholders (creditors) have a legal priority for the repayment of their principal and interest before any distribution can be made to stockholders (owners). This hierarchical claim structure ensures that bondholders are paid before stockholders, further reducing their investment risk.
Statements II and III collectively explain Statement I. The status of bondholders as lenders (Statement II) with a contractual claim, combined with their priority in repayment during financial distress (Statement III), directly contributes to their lower investment risk compared to stockholders.
Incorrect Options
Option (2) is incorrect because Statement III is also factually correct and provides a crucial explanation for the lower risk associated with bondholders as described in Statement I.
Option (3) is incorrect because both Statement II and Statement III are factually correct statements.
Option (4) is incorrect because both Statement II and Statement III are factually correct statements.