Accredited Wealth Management Advisor Practice Exam

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What type of risk is a company increasing by borrowing large amounts of money?

Financial risk
Systematic risk
Interest rate risk
Market risk

The correct answer is: Financial risk

A company that borrows large amounts of money significantly increases its financial risk. Financial risk specifically refers to the possibility that a company will not be able to meet its financial obligations, such as repaying debt or covering interest payments. When a company takes on debt, it increases its leverage, which can amplify both potential returns and potential losses. Higher levels of debt mean that a larger portion of the company’s cash flow must be used to service that debt, increasing vulnerability during downturns in performance or cash flow. In contrast, systematic risk refers to market-wide risks that affect all securities, such as economic shifts or geopolitical events, and interest rate risk deals specifically with the potential for changes in interest rates to impact the value of bonds or the cost of servicing debt. Market risk encompasses overall market movements that can impact the value of investments but does not specifically relate to the financial obligations of a company due to borrowing. Thus, the increase in indebtedness primarily enhances the company’s financial risk profile.