What is financial risk?

Question

BlackTom AI · Accepted Answer

To approach this question, we first consider the concept of financial risk and what it specifically relates to in corporate finance.
Option a: 'Risk from external market conditions' describes market risk or systematic risk, which affects the value of assets due to factors like interest rates, exchange rates, or economic cycles, not the financing structure itself. Therefore, this is not the definition of financial risk.
Option b: 'Risk from how the company is financed' directly points to financial risk, which arises from the choices a firm makes about its funding—from debt levels to equity structure—and the potential for financial distress if cash flows are insufficient to meet obligations.
Option c: 'Risk from regular business operations' corresponds to operating risk, which stems from the day-to-day activities of producing goods or services, not from financing decisions. This is separate from financial risk.
Option d: 'Risk from changes in government policies' would be considered regulatory or political risk, involving potential impacts from policy shifts, taxes, or sanctions, not the financial structure of the company.
Thus, each of the other options identifies a different category of risk, while option b uniquely matches the definition of financial risk by focusing on financing decisions and their consequences.

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