The financial risk is:
Answer & explanation
Correct answer: option 4
The correct answer is Option (4) → A firm would fail to meet its payment obligations
Option (1) A firm would fail to meet its legal and compliance obligations — Incorrect. Failing to follow the law is a legal matter. It is not the risk that comes from borrowing.
Option (2) A firm would fail to meet its audit and statutory obligations — Incorrect. Audit and statutory duties are also legal requirements, not financial risk.
Option (3) A firm would fail to meet its productivity commitments — Incorrect. Productivity is about output and efficiency in operations. It has nothing to do with paying lenders.
Option (4) A firm would fail to meet its payment obligations — Correct. Interest on borrowed funds must be paid whether or not the firm earns a profit, and the loan must be repaid on a fixed date. The risk of default on these payments is called financial risk. The more debt a firm has in its total capital, the higher this risk. Shareholders’ funds carry no such fixed payments.
NCERT (2026-27 Edition): “Financing Decision … It involves identification of various available sources. The main sources of funds for a firm are shareholders’ funds and borrowed funds. The shareholders’ funds refer to the equity capital and the retained earnings. Borrowed funds refer to the finance raised through debentures or other forms of debt. A firm has to decide the proportion of funds to be raised from either sources, based on their basic characteristics. Interest on borrowed funds have to be paid regardless of whether or not a firm has earned a profit. Likewise, the borrowed funds have to be repaid at a fixed time. The risk of default on payment is known as financial risk which has to be considered by a firm likely to have insufficient shareholders to make these fixed payments. …” |