CFA Practice Question

There are 120 practice questions for this study session.

CFA Practice Question

Which of the following statements best describes the difference between financial leverage and financial risk?
A. Financial risk refers to the risk that a company may default on its debt and thus transfer the possession of the firm away from shareholders and to creditors. Financial leverage, on the other hand, measures the effect interest payments have on pre-tax profits.
B. As financial risk increase, financial leverage ratios will decrease.
C. While an increase in financial leverage may increase the volatility in pre-tax earnings, it does not necessarily mean that a company's probability of default will increase.
Explanation: Financial risk uses balance sheet variables to measure how heavy the debt burden is on the company. Financial leverage uses income statement items to determine how much impact interest expense has on the volatility of pre-tax earnings.

User Contributed Comments 2

User Comment
angelafan why C is wrong?
poomie83 when pre-tax earnings are diminished due to increase in Interest, this will always increase the risk of default but the company may not default.
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