Which of the following statements is CORRECT? (Points: 4)
Junk bonds typically provide a lower yield to maturity than investment grade bonds.
A debenture is a secured bond that is backed by some or all of the firm's fixed assets.
Subordinated debt has less default risk than senior debt.
Junior debt is debt that has been more recently issued, and in bankruptcy it is paid off after senior debt because the senior debt was issued first.
Convertible bonds have lower coupon rates than non-convertible bonds of similar default risk because they offer the possibility of capital gains.
To determine which statement is correct, let's analyze each option:
1. Junk bonds typically provide a lower yield to maturity than investment grade bonds.
To verify this statement, we need to compare the yield to maturity of junk bonds and investment grade bonds. To do this, one could research the current yield to maturity of both types of bonds and compare the numbers. Generally, junk bonds are considered riskier, so they tend to offer higher yields to compensate for the increased risk. Therefore, this statement is incorrect.
2. A debenture is a secured bond that is backed by some or all of the firm's fixed assets.
To confirm this statement, we need to understand the definition of a debenture and how it differs from other types of bonds. Researching the characteristics of a debenture will show that it is an unsecured bond, meaning it is not backed by any specific collateral. Therefore, this statement is incorrect.
3. Subordinated debt has less default risk than senior debt.
To determine the validity of this statement, we need to evaluate the default risk of subordinated debt and senior debt. Generally, subordinated debt has a higher default risk because it ranks lower in priority during a bankruptcy or default situation. Therefore, this statement is incorrect.
4. Junior debt is debt that has been more recently issued, and in bankruptcy, it is paid off after senior debt because the senior debt was issued first.
To evaluate this statement, we need to understand the hierarchy of debt repayment in bankruptcy. Researching the order of debt payment during bankruptcy will confirm that junior debt, which includes subordinated debt, is paid off after senior debt. This is because senior debt has priority in repayment due to being issued first. Therefore, this statement is correct.
5. Convertible bonds have lower coupon rates than non-convertible bonds of similar default risk because they offer the possibility of capital gains.
To validate this statement, we need to understand the characteristics of convertible bonds and how they differ from non-convertible bonds. Researching convertible bonds will reveal that they typically have lower coupon rates because they offer the potential for capital gains if the bondholder chooses to convert them into equity. Therefore, this statement is correct.
In summary, the correct statement among the options provided is:
Junior debt is debt that has been more recently issued, and in bankruptcy, it is paid off after senior debt because the senior debt was issued first.