Looking for the answer to the question below related to Financial Management ?
When the risk perception is high, investor prefers to get the bond at
Options:
| A. Higher rate B. Reduced rate C. Par rate D. None of these |
The Correct Answer Is:
- B. Reduced rate
Option B, “Reduced rate,” is the correct answer when the risk perception is high for investors. In such situations, investors perceive bonds as riskier investments, and they demand a higher return to compensate for the increased risk. This higher return is reflected in the form of a reduced rate or yield on the bond.
When risk perception is high, investors are concerned about the possibility of default or the issuer’s inability to make timely interest payments or return the principal amount. Therefore, they require a higher rate of return to justify the additional risk they are taking.
By demanding a reduced rate, investors are effectively increasing the yield or return they expect to receive from the bond. This reduced rate compensates them for the higher risk associated with the investment.
Now let’s explore why the other options are not correct:
A. Higher rate:
While it may seem intuitive to assume that investors would prefer a higher rate when risk perception is high, it is not the case. When the risk perception is high, investors become more cautious and demand a higher rate of return to compensate for the additional risk.
Therefore, they do not prefer to get the bond at a higher rate, but rather they demand a higher rate.
C. Par rate:
The par rate refers to the interest rate at which a bond is issued, and it is typically based on prevailing market conditions and the issuer’s creditworthiness. It represents the rate at which the bond is sold at face value.
However, when risk perception is high, investors perceive the bond as riskier, and they demand a higher return to compensate for that risk. Therefore, the par rate is not preferred by investors in such situations.
D. None of these:
This option is not correct because there is a specific preference for a reduced rate when risk perception is high. As explained earlier, investors require a higher return to offset the increased risk, and this higher return is reflected in the form of a reduced rate or yield on the bond.
Conclusion
In conclusion, when risk perception is high, investors prefer to get the bond at a reduced rate. This preference arises because they demand a higher return to compensate for the additional risk associated with the investment.
By choosing a reduced rate, investors increase the yield or return they expect from the bond, thereby adequately compensating themselves for the heightened risk. It is essential for investors to consider risk perception carefully and evaluate the potential returns to make informed investment decisions.
