Asset substitution

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Asset substitution

Occurs when a firm invests in assets that are riskier than those that the debtholders expected.

Asset Substitution

A company's exchange of lower-risk investments for higher-risk investments. Firms may use asset substitution as a form of financing, or as a move to please shareholders. It can be detrimental to the company's bondholders as it increases the possibility of default without any corresponding benefit because bonds have a fixed interest rate. On the other hand, asset substitution can benefit shareholders as it carries the possibility of higher returns.
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A customized financing structure with the additional flexibility of asset substitutions resulting in a win-win solution for both borrower and lender," said Ganong.