Which one of the following is the equity risk arising from the capital structure selected by a firm?

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Question restatement: Which one of the following is the equity risk arising from the capital structure selected by a firm?

Option 1: Strategic risk. This refers to risks associated with the overall direction and strategy of a firm, such as competitive positioning or strategic decisions. It is not specifically tied to the financial structure or the leverage chosen, so it does not capture the equity risk arising from capital structure.

Option 2: Business risk. This concerns the inherent risk of the firm's operations and cash flows before regard to the mix of debt and equity. It reflects the industry, demand, and operational factors, rather than financing choices, so it does not describe equity risk from capital structure.

Option 3: Liquidity risk. This is the risk that a firm cannot meet short-term financial obligations due to insufficient liquid assets or market access. While leverage can influence liquidity, liquidity risk is more about cash flow timing and liquidity position rather than the fundamental equity risk caused by capital structure decisions.

Option 4: Industry risk. This involves risks associated with the broader industry in which the firm operates, such as regulatory changes or cyclical demand. It is not a consequence of how capital is financed, so it does not represent equity risk stemming from capital structure.

Option 5: Financial risk. This describes the risk to equity holders that arises specifically from the use of debt in the capital structure. Higher leverage amplifies variability in earnings and return on equity, making this the equity risk associated with financing choices.

BFIN011 Week 10: Practice Quiz

Which one of the following is the equity risk arising from the capital structure selected by a firm?

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