Los 21.a

Question 1

What is the key difference between debtholders and equity holders

Answer 1

Debtholders have a legal claim to interest and principal payments.

Equity holders have a residual claim to the company’s net assets after all debts are paid.

Debt has priority over equity and is less risky and less costly

Question 2

How do debt and equity investments differ in risk and upside potential?

Answer 2

Debtholders can lose their investment but cannot gain beyond promised payments.

Equity holders can lose their investment but have unlimited upside if the company grows.

Question 3

What makes up a company’s total value?

Answer 3

The value of its debt plus the value of its equity.

Question 4

How are debt investors exposed to company performance?

Answer 4

Debt investors have no upside, only downside if the company underperforms.

If revenues fall too much, debt investors might not receive full promised payments.

Question 5

Why might the interests of debtholders and equity holders conflict?

Answer 5

Equity holders favor riskier actions to increase returns (like taking on more debt).

Debtholders prefer lower risk to protect their investment.