Share
Explore BrainMass

Example of fairly priced securities

When securities are fairly priced, why would the original shareholders of a firm pay the present value of bankruptcy and financial distress costs?

Solution Preview

This is a curious question but I think I understand what is being asked. If I didn't, please give me a little more information.

When securities are fairly priced:
This would indicate that the market price of the stock of the company has gone down considerably to reflect the risk involved in bankruptcy. Companies often file Chapter 11 - reorganization in the hopes of shedding some debt and becoming solvent and viable once again.

The original shareholders:
This must mean that the current shareholders have owned stock in the company for some time and have seen the value of their holding decrease because of losses and pending bankruptcy. Shareholders are in a loss position with their investment at this point in a company's existence.

Pay the present ...

Solution Summary

Why original shareholders of a firm pay the present value of bankruptcy and financial distress costs when securities are fairly priced is determined.

$2.19