The asset substitution problem occurs when:
A) managers substitute riskier assets for less risky ones to the detriment of bondholders.
B) managers substitute less risky assets for riskier ones to the detriment of bondholders.
C) managers substitute riskier assets for less risky ones to the detriment of equity holders.
D) managers substitute less risky assets for riskier ones to the detriment of equity holders.

Question

Quizplus · Accepted Answer

The asset substitution problem occurs when managers substitute riskier assets for less risky ones to the detriment of bondholders. This is because bondholders are more concerned with the safety of their investment and want less risky assets to back their bonds. By substituting riskier assets, the value of the bond decreases and the risk for bondholders increases.

The Asset Substitution Problem Occurs When