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

Which of the following is a recognized indirect cost of financial distress that a risk manager should consider when assessing a levered portfolio company?

Loss of customers and key employees who doubt the firm's survival is an indirect cost of financial distress. Legal and administrative fees are direct costs, while the interest tax shield is a benefit of debt rather than a distress cost.

  1. ALegal and administrative fees paid after a bankruptcy filing
  2. BLoss of customers and key employees who doubt the firm's survivalCorrect
  3. CInterest tax shield from higher debt
  4. DLower agency costs from reduced managerial discretion

Explanation

Indirect costs include lost sales, departing key staff, tighter supplier terms and underinvestment due to fear of failure. Legal and administrative fees are direct costs. The tax shield is a benefit of debt, and lower agency costs is not a distress cost.

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