The chance that a firm would fail to meet its payment obligations, such as interest and repayment of loans, is known as:
Answer & explanation
Correct answer: option 2
The correct answer is Option (2) → Financial risk
Option (1) Business risk — Incorrect. Business risk is also called operating risk. It depends on fixed operating costs such as rent and salaries. It does not arise from interest or loan repayment.
Option (2) Financial risk — Correct. Financial risk is the position where a company cannot meet its fixed financial charges: interest, preference dividend and repayment of loans. It grows as the share of debt in the capital grows.
Option (3) Market risk — Incorrect. Market risk comes from changes in market conditions, such as share prices or interest rates. It hits firms in general, not a firm’s failure to pay its own dues.
Option (4) Total risk — Incorrect. Total risk is the business risk and the financial risk taken together. The failure to pay interest and loans is only the financial part.
NCERT (2026-27 Edition): “9. Risk Consideration: As discussed earlier, use of debt increases the financial risk of a business. Financial risk refers to a position when a company is unable to meet its fixed financial charges namely interest payment, preference dividend and repayment obligations. Apart from the financial risk, every business has some operating risk (also called business risk). Business risk depends upon fixed operating costs. Higher fixed operating costs result in higher business risk and vice-versa. The total risk depends upon both the business risk and the financial risk. If a firm’s business risk is lower, its capacity to use debt is higher and vice-versa.” |