CFA Level I · CFA Level I Exam · Equity Instrument Features
A start-up with volatile earnings needs long-term capital and wants to avoid fixed obligations that could trigger insolvency. Which source of financing is most appropriate?
Issuing common equity is most appropriate. It creates no mandatory interest or principal payments and has no maturity date, so volatile earnings cannot push the firm into default. Bonds and bank loans impose fixed legal obligations that can cause insolvency when cash flows fall short.
- AIssuing common equityCorrect
- BIssuing a bond with a fixed coupon
- CTaking a floating-rate bank loan
Explanation
Common equity carries no mandatory payments and no maturity, so it cannot trigger insolvency through missed payments. Both the fixed-coupon bond and the bank loan require interest and principal repayment regardless of earnings.
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