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Difficulty: HardNon-Systematic and Credit Risks

Match each corporate scenario describing a specific microeconomic threat to its corresponding category of non-systematic risk.

  • A corporate bond issuer experiences operational disruptions that trigger a rating agency downgrade due to heightened probability of principal default.Credit (Default) Risk
  • An investor holding a thinly traded municipal revenue bond must sell quickly but faces significant price concessions to execute the transaction.Liquidity Risk
  • A manufacturer suffers severe profit erosion following product recalls and mismanaged supply chain decisions.Business Risk
  • A firm with extreme debt leverage faces insolvency risk primarily due to its inability to service fixed debt obligations.Financial Risk

Answer

Credit (Default) Risk matches the scenario involving bond rating downgrades and principal default probability; Liquidity Risk matches the scenario regarding selling thinly traded securities at a discount; Business Risk matches the operational profit erosion scenario; Financial Risk matches the corporate debt leverage and solvency scenario.
Each scenario aligns with a specific category of unsystematic risk: Credit risk addresses issuer default likelihood and credit downgrades; Liquidity risk involves difficulty liquidating a security rapidly without price concessions; Business risk originates from operational and managerial failures; Financial risk stems from high debt leverage within a company's capital structure.

Step-by-Step Solution

1
Analyze the scenario involving bond rating downgrades and default probability.
Identify this as Credit (Default) Risk because it directly concerns the issuer's creditworthiness and ability to meet debt obligations.
Credit risk specifically measures issuer default probability and credit rating actions.
2
Analyze the scenario involving selling a thinly traded bond under time constraint.
Identify this as Liquidity Risk because the primary loss factor is marketability and price concessions required to execute a fast sale.
Liquidity risk focuses on the speed and cost of converting an investment into cash.
3
Analyze the scenario concerning product recalls and supply chain mismanagement.
Identify this as Business Risk because operational efficiency and management decision-making directly impact operating earnings.
Business risk reflects firm-specific operational and competitive vulnerabilities.
4
Analyze the scenario concerning capital structure and debt servicing capability.
Identify this as Financial Risk because excessive debt leverage creates mandatory interest and principal burdens that risk insolvency.
Financial risk is tied directly to a firm's capital structure and debt financing choices.

Key Concept

Classification of Unsystematic (Non-Systematic) Risks
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Topics

Non-Systematic and Credit Risks

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