A position when a company is unable to meet its fixed financial charges like interest payment, dividend on preference shares and repayment obligations is referred to as .
A position when a company is unable to meet its fixed financial charges like interest payment, dividend on preference shares and repayment obligations is referred to as .
Options
Official answer
The correct option is (B) Financial risk.
Reason: Financial risk is the danger that a firm may not be able to meet its fixed financial charges — interest on debt, preference dividend and repayment of principal. These arise from using borrowed funds (debt) in the capital structure.
Marking scheme
- 1.1 mark: correct option (B) Financial risk.
- 2.No marks for related but distinct terms like business risk or trading on equity.
Hint
Fixed FINANCIAL charges from debt → the risk named after finance.
Quick oral answer
Financial risk — it is the chance that a firm cannot meet its fixed financial obligations like interest, preference dividend and repayment of borrowed funds, and it rises as debt in the capital structure increases.
Common mistakes
- 1.Confusing financial risk with business risk — business risk stems from operations, financial risk from the use of debt.
- 2.Choosing 'trading on equity', which is a strategy to boost equity returns using debt, not the risk of failing to pay fixed charges.
- 3.Mixing up 'operating risk' (operating costs) with financial risk (financial charges).
Analysis and explanation
This question defines financial risk in the context of capital structure.
Concept
When a company raises funds through debt, it commits to fixed payments (interest, preference dividend, principal repayment). If earnings are insufficient to cover these, the firm faces financial risk — the possibility of default/insolvency.
Why (B) is right
The definition in the question — inability to meet fixed financial charges — is the exact textbook definition of financial risk.
Why the distractors are wrong
- (A) Trading on equity: The opposite idea — using debt to increase the return to equity shareholders when ROI exceeds the cost of debt. It is a strategy, not a risk of default.
- (C) Business risk: Arises from the nature of business operations and demand/cost fluctuations, unrelated to how the firm is financed.
- (D) Operating risk: Relates to the firm's operating (fixed operating) costs and operations, not to fixed financial charges from debt.
Exam trap: Distinguish financial risk (financing/debt) from business/operating risk (operations). The keyword 'fixed financial charges' locks in financial risk.
Interesting facts
Higher proportion of debt in the capital structure increases financial risk but can also raise EPS through trading on equity — the two are two sides of the same debt coin.
Business risk exists even in a fully equity-financed firm, but financial risk appears only when the firm borrows — that is why a debt-free company has zero financial risk.
Question details
Q12 of 37 questions
- Board
- CBSE
- Class
- Class 12
- Subject
- Business Studies
- Year
- 2026
- Section
- Section A
- Marks
- 1
- Type
- MCQ
- Chapter
- Financial Management
- Topic
- Financial Risk in Capital Structure
- Bloom's level
- understand
- Syllabus topic
- Unit 8: Financial Management — Capital Structure and Financial Risk
- Author
- CBSE
- Reviewed by
- Padhantu Academic Team
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Frequently asked questions
What is the difference between financial risk and business risk?
Business risk arises from the firm's operations and demand/cost uncertainties and exists even without debt. Financial risk arises only from the use of borrowed funds and is the danger of being unable to pay fixed financial charges like interest and principal. More debt raises financial risk.
How does financial risk relate to trading on equity?
Both come from using debt. Trading on equity is the benefit — higher EPS when return on investment exceeds interest cost. Financial risk is the downside — if earnings fall, the firm may be unable to meet its fixed charges. A finance manager balances the two while designing capital structure.