Consider the following statements:

Statement I: As regards returns from an investment in a company, generally, bondholders are considered to be relatively at lower risk than stockholders.

Statement II: Bondholders are lenders to a company whereas stockholders are its owners.

Statement III: For repayment purpose, bondholders are prioritised over stockholders by a company.

Which one of the following is correct in respect of the above statements?

The correct option is Both Statement II and Statement III are correct and both of them explain Statement I.

Let us analyze each statement to understand why this option is correct:

Analysis of Statement I:
Statement I asserts that bondholders are generally considered to be at a relatively lower risk than stockholders regarding returns from an investment in a company. This statement is correct. Debt instruments (bonds) offer more predictable and stable returns (interest payments) compared to equity (stocks), which depend heavily on the company's profitability and market performance.

Analysis of Statement II:
Statement II states that bondholders are lenders to a company whereas stockholders are its owners. This statement is correct. Bonds represent debt, meaning bondholders lend money to the corporation in exchange for periodic interest payments and the return of principal at maturity. Stockholders, on the other hand, purchase shares of ownership in the company and bear the ultimate business risks and rewards.

Analysis of Statement III:
Statement III states that for repayment purposes, bondholders are prioritized over stockholders by a company. This statement is also correct. In the event of a company's liquidation or bankruptcy, there is a legal hierarchy of claims. Debt claims (including bondholders) must be fully satisfied before any remaining assets can be distributed to equity owners (stockholders).

Relationship between the Statements:
Since bondholders are lenders (creditors) rather than owners (Statement II), they have a contractual right to receive interest payments before any dividends can be paid to stockholders. Furthermore, because bondholders hold priority claim in the event of repayment or liquidation (Statement III), their capital is much safer than that of stockholders. Together, the creditor status of bondholders (Statement II) and their priority in repayment (Statement III) directly explain why investing in bonds carries a lower risk compared to investing in stocks (Statement I).