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Brief Principles of Macroeconomics...

8th Edition
N. Gregory Mankiw
ISBN: 9781337091985

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BuyFindarrow_forward

Brief Principles of Macroeconomics...

8th Edition
N. Gregory Mankiw
ISBN: 9781337091985
Textbook Problem

Elaine wants to buy and operate an ice-cream truck but doesn’t have the financial resources to start the business. She borrows $10,000 from her friend George, to whom she promises an interest rate of 7 percent, and gets another $20,000 from her friend Jerry, to whom she promises a third of her profits. What best describes this situation?

a. George is a stockholder, and Elaine is a bondholder.

b. George is a stockholder, and Jerry is a bondholder.

c. Jerry is a stockholder, and Elaine is a bondholder.

d. Jerry is a stockholder, and George is a bondholder.

To determine

The difference between the Stock and the Bond.

Answer

Option 'd' is correct.

Explanation

Both the Stocks and the Bonds are the financial market instruments used by the people in the economy. Amongst them, the share provides the ownership right to those who holds them whereas the Bond is an income investment which is fixed and thus it acts as a certificate of indebtedness. There are many matches between the Stocks and the Bonds. Both of them are financial instruments, used to raise capital to the firm, traded on exchange and both entail risks.

Option (d):

The stock makes the holder of the stock to be a shareholder of the firm which issues the stock. This means the stock holder holds the ownership share of the firm and thus, the stock provides the share of the firm's profit to the stock holder. The Bond on the other hand is a certificate of indebtedness which guarantees the repayment of the loan amount when the bond matures and it provides interest to the loan issuer by the taking firms. Here, individual J offered one-third of the profit of the firm which means Jerry is a stock holder whereas the individual George who receives interest for the amount provided is a bond holder. Thus, option 'd' is correct.

Option (a):

The stock makes the holder of the stock to be a shareholder of the firm and it provides the share of the firm's profit to its holder whereas the Bond is a certificate of indebtedness which guarantees the repayment of the loan amount after the maturity period of the bond. Here, Elaine is the issuer of Bond and stock to George and Jerry because he takes the money from both of them to create capital and start the business. Here, George receives interest and jerry receives share of profit. So George is the Bond holder and Jerry is the stockholder. Since, Elaine is not amongst the two groups, option 'a' is incorrect.

Option (b):

The stock makes the holder of the stock to be a shareholder of the firm and it provides the share of the firm's profit to its holder whereas the Bond is a certificate of indebtedness which guarantees the repayment of the loan amount after the maturity period of the bond.

Here, George receives interest which is received on the Bonds and Jerry receives share of profit which is by the stock. Thus, they are Bond holders and stock holders respectively. Since the option explains them inversely, option 'b' is incorrect.

Option (c):

The stock provides share of profit to the holder of the stock and thus, Jerry who receives the profit share of the firm is a stockholder. But Elaine is the individual who issues the Bonds and stocks in order to raise the capital need for the firm and thus he is neither a bondholder nor a stockholder. Since option explains Elaine as a Bondholder, option 'c' is incorrect.

Concept

Concept introduction:

Stock: A stock means a partial ownership of the firm. The stocks are the shares are sold to the people in order to raise the capital for the firm. Thus, those who owns stocks owns the share of the ownership of the firm.

Bond: It is the certificate of indebtedness of the bond issuer to the holder. So, it is a fixed income investment in which an investor loans capital to an entity for a period of time at variable interest rates.

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