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

A risk manager at a fund of funds reviews a portfolio company that has begun losing key customers and suppliers because they doubt it will survive. Which category of financial distress cost does this best illustrate?

This is an indirect cost of financial distress. Customers and suppliers who doubt the firm will survive reduce business or tighten terms, eroding operating value before any filing. Direct costs are explicit legal and administrative fees, which are not what is described here.

  1. AIndirect cost arising from lost sales and weakened supplier relationshipsCorrect
  2. BDirect cost consisting of legal and administrative fees in bankruptcy
  3. CTax shield benefit from higher leverage
  4. DAgency cost of equity arising from managerial perquisites

Explanation

Customers and suppliers withdrawing because of survival doubts is a classic indirect distress cost, as it erodes operating value before any formal filing. Direct costs are explicit fees such as legal and administrative expenses. The other options are unrelated to the loss of business relationships.

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