The additional risk associated with a firm's earnings when it uses debt capital is known as
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A. B. C. D.D
Financial risk is the additional risk associated with a firm's earnings when it uses debt capital.
The additional risk associated with a firm's earnings when it uses debt capital is known as financial risk.
Explanation:
Financial risk refers to the risk that arises due to a firm's capital structure decisions, specifically the use of debt financing. When a company uses debt to finance its operations or investments, it incurs fixed interest obligations that need to be met regardless of the firm's earnings. This creates an additional burden on the company's profitability and can magnify the impact of changes in earnings.
The key characteristic of financial risk is that it is specific to a firm's capital structure and the use of debt. It is different from other types of risks such as business risk, systematic risk, and capital market risk, which have distinct definitions.
A. Business risk refers to the risk inherent in a firm's operations and is associated with factors such as competition, market demand, and the company's ability to generate profits from its core business activities. Business risk is not directly related to the use of debt capital.
B. Systematic risk, also known as market risk, refers to the risk that is common to the entire market or a specific segment of the market. It is caused by factors such as economic conditions, interest rates, and geopolitical events. Systematic risk affects all firms in the market and is not specific to a company's capital structure.
C. Capital market risk refers to the risk that arises from fluctuations in the overall market, such as changes in interest rates, inflation, or investor sentiment. It is not directly related to a company's capital structure decisions.
D. Financial risk, as mentioned earlier, is the risk associated with a firm's use of debt capital. It arises due to the fixed interest obligations and the potential impact of changes in earnings on the company's ability to meet its debt obligations.
In summary, financial risk is the additional risk associated with a firm's earnings when it uses debt capital. It is separate from business risk, systematic risk, and capital market risk, as it specifically pertains to the impact of debt on a company's financial performance and obligations.