Question

The debt-equity ratio determines the amount of _____ risk that is associated with a firm.

		business
		systematic
		unsystematic
		financial

Answer 1

A debt to equity ratio would determine the amount of financial risk that is associated with the company

Financial risk is simply the risk that a company defaults on the repayment of its liabilities. When debt-to-equity ratio is high, it increases the likelihood that the company defaults and is liquidated as a result. Obviously, this is not good for investors and lenders because it increases the risk associated with their investment or lending which causes them to require a higher rate of return to compensate for the additional risk. Increase in the required return of investors and lenders means an increase in the cost of capital to the company.