Question

What is financial risk and how does it affect interest rate?

Answer 1

Financial risk is a risk of default on obligation ( i.e debt payments). In other words, it is a possibility that firm would not be able to pay off its obligation.

Firm's with more debt in its capital structure has higher financial risk. Financial risk directly affects interest rate which means if a firm has higher financial risk then an investor demands higher interest rate to invest in the firm.

Some component of Financial risk listed below:

• Liquidity risk
• Credit risk
• Asset-backed risk
• Currency risk