Question

In: Finance

As an investor today, what would you buy stocks or bonds? Why? (choose only one, please,...

As an investor today, what would you buy stocks or bonds? Why? (choose only one, please, and use in your answer the difference between the two).

As a CEO of a corporation what would you recommend to the Board of Directors as a source of financing, stocks or bonds? Why?

Solutions

Expert Solution

As an investor today I would buy stocks rather than bonds because stocks provide a higher risk adjusted return in the long run.

The bonds provide a fixed regular income but that may not be sufficient to compensate for the inflation. Equity, on the other hand, has the potential to beat inflation over a long enough period, so that our purchasing power increases.

As a CEO of a corporation, I would recommend to the Board of Directors to finance the capital with bonds. Bonds are cheaper than equity because the bonds are backed by the assets of the company.

According to Pecking Order Theory, the order of preference to raise capital is through 1) Internal financing, 2) Debt, and 3) Equity

If we go by this order, Debt raised through bonds is preferred to Equity. Debt provides tax benefits as the interest paid to bond holders are tax deductible. In addition, Debt lowers the weighted average cost of capital for the company.


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