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FRM Part II · FRM Exam Part II · Distress Symptoms and Remedies

A risk manager at a fund of funds is reviewing a levered operating company held by a distressed-debt manager. Which of the following is most clearly an early symptom of financial distress, rather than a cause of it?

Suppliers shortening payment terms and demanding cash on delivery is a symptom of distress, because it shows trade creditors doubt the firm's ability to pay. The other actions, such as raising dividends, issuing long-term bonds or raising equity, do not signal deteriorating solvency.

  1. AManagement raising dividends to signal confidence
  2. BSuppliers shortening payment terms and demanding cash on deliveryCorrect
  3. CThe firm issuing long-term fixed-rate bonds to lengthen maturity
  4. DAn increase in the firm's cash balance after an equity issuance

Explanation

Suppliers tightening credit terms or requiring cash on delivery reflects lost confidence in the firm's ability to pay, so it is a symptom of distress. Dividend increases and equity issuance are not distress signals, and lengthening debt maturity usually reduces rollover risk.

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