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

Which of the following is typically an early warning symptom that a firm may be heading toward financial distress?

Rising reliance on short-term borrowing together with widening bond credit spreads is an early distress warning, because it shows growing rollover risk and the market pricing a higher default probability. Deleveraging, extra long-term-funded cash and lower equity volatility point to improving, not worsening, health.

  1. ARising reliance on short-term borrowing and widening credit spreads on its bondsCorrect
  2. BA decline in the debt-to-equity ratio after an equity issue
  3. CAn increase in cash reserves funded by long-term debt
  4. DFalling volatility of the firm's equity price

Explanation

Increasing dependence on short-term funding signals rollover risk, and widening credit spreads show the market is pricing a higher default probability. The other options reflect deleveraging, stronger liquidity or lower risk, which are not distress symptoms.

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