Can anyone help me to answer this question? Q1) A)Income bonds. Income bonds are

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Can anyone help me to answer this question?

Q1) A)Income bonds. Income bonds are unusual.interest payments on such bonds may be skipped or deferred if the firm's income is insufficient to make the payment. In what way are these bonds like preferred stock? Why might a firm choose to issue an income bond instead of preferred stock?

B) Preferred stock. Preferred stock of financially strong firms sometimes sells at lower yields than the bonds of those firms. For weaker firms, the preferred stock has a higher yield. What might explain this pattern?

Explanation / Answer

A)
Preferred stock receives dividend like income bonds receive coupon payment.
Both get a lower priority compared to Actual Bonds and higher priority compared to common stock. The returns are based on the company performance.

Income bonds have tax exemptions unlike preferred stock, making them more favorable.

B)
In a financially strong firm, the default risk is very low. making the default premium very low.
The liquidity premium becomes significant in these cases. Preferred stock has a low liquidity premium than bonds, making them have lower yield than bonds.
In financially weak firms, default premium dominates and since bonds have higher preference over preferred stock, they have lower yield than stock.

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