A firm's systematic risk will ____________ as its debt/equity ratio __________.
A) Increase; increases.
B) Decrease; increases.
C) Remain unchanged; decreases.
D) Remain unchanged; increases.
E) First increase, and then decrease; increases.

Question

Quizplus · Accepted Answer

Systematic risk, also known as market risk, is influenced by factors that affect the entire market, such as economic, political, and social events. The use of debt increases a firm's financial leverage, which amplifies the potential returns to equity holders but also increases the risk. As the debt/equity ratio increases, the firm's financial risk increases because the firm has more obligations to meet (interest payments on debt), which can amplify the effects of market-wide events on the firm. Therefore, a firm's systematic risk increases as its debt/equity ratio increases.

A Firm's Systematic Risk Will ____________ as Its Debt/equity Ratio