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

A treasurer notes that suppliers have begun demanding cash on delivery and that several senior engineers have left after the firm's credit rating was cut to speculative grade. These effects most directly illustrate which cost of financial distress?

These are indirect costs of distress: stakeholders such as suppliers and employees react to higher default risk, which erodes enterprise value even before any bankruptcy filing. They are not administrative filing costs, tax-shield effects or free-cash-flow agency costs.

  1. ALost enterprise value from stakeholder reactions to elevated default riskCorrect
  2. BDirect administrative costs of a formal bankruptcy filing
  3. CTax shield loss from reduced interest deductions
  4. DAgency cost of free cash flow

Explanation

Suppliers tightening trade credit and employees leaving are stakeholder responses to higher perceived default risk, eroding enterprise value. They are indirect costs, not formal bankruptcy administration costs, tax effects or free cash flow agency issues.

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