Question

Mark and Sally both decided to invest in the same company. Mark does not like risk, so he purchased bonds from the company. Sally does not mind a little bit of risk, so she purchased stock from the company. What is the difference between Mark’s and Sally’s expectations of the company?

Answer 1

Answer:

As Mark taking lower risk, his expected returns from the company is lower. Whereas on the other hand, Sally is facing higher risk so its expected return will be higher than Mark.

Explanation:

The risk in investing in stock is higher than the bonds because the return is first paid to the bond holder according to their coupan rate. If their is still profit left, then the taxes on this profit after interest and before tax is computed and paid off. If still their is profit left undistributed then it will go to prefference shareholders. Now again, if still their is undistributed profits left then it will be distributed to ordinary shareholders.

From above explanation we concluded that ordinary shareholders face higher risks than the remainder fund providers, hence their expected return for higher risks are ofcourse higher than the fund providers.