Your firm’s CEO has just learned about options and how your firm’s equity can be viewed as an option. Why might he want to increase the riskiness of the firm, and why might the bondholders be unhappy about this?

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Your firm’s CEO has just learned about options and how your firm’s equity can be viewed as an option. Why might he want to increase the riskiness of the firm, and why might the bondholders be unhappy about this?

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Your firm’s CEO has just learned about options and how your firm’s equity can be viewed as an option. Why might he want to increase the riskiness of the firm, and why might the bondholders be unhappy about this?

Explanation & AnswerSolution by a verified expert

Explanation

When there is risk in the firm, then any other company does think of taking over such risky firms. Therefore, to avoid such takeover by other companies, firms try to increase risk. Because as the risk increases, the companies thinking to acquire the firm may change its decision.
 
By investing in equity the funds from bondholders will shift to shareholders because the investment in equity will be from bondholders expenses. Therefore, this makes bondholders unhappy.

Verified Answer

So as to avoid the potential takeover by some other companies, the riskiness of the firm will be increased.
 
There will be shifting of funds from bondholders to shareholders, making bondholders unhappy.

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