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

A risk manager at a pension fund reviews a leveraged manufacturing firm whose bonds have fallen sharply. Which item is best classified as an INDIRECT cost of financial distress?

Loss of customers who doubt the firm's ability to honor warranties is an indirect cost of financial distress, because it is lost business and opportunity. Legal, advisory and administrator fees are direct, explicit costs of the restructuring or bankruptcy process.

  1. ALegal fees paid to bankruptcy counsel during a court-supervised restructuring
  2. BFees paid to an investment bank advising on a debt exchange
  3. CLoss of key customers who doubt the firm will honor long-term warrantiesCorrect
  4. DCourt-appointed administrator fees paid from the estate

Explanation

Indirect costs are opportunity and business-erosion costs such as lost customers, suppliers tightening terms, and lost key employees. Legal, advisory and administrator fees are direct, out-of-pocket costs of the distress or bankruptcy process.

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