Question

If a firm increases its leverage ratio, it

a) has debts that exceed the value of its assets.
b) is at a greater risk for becoming insolvent.
c) has a lower risk of defaulting on loans.
d) is better able to securitize its assets.

Answer 1

b) is at a greater risk for becoming insolvent.

Step-by-step explanation:

If a firm increases its leverage ratio, it means that it is taking on more debt relative to its equity. The leverage ratio is the proportion of a company's debt to its equity. With that in mind: b) is at a greater risk for becoming insolvent.

Increasing the leverage ratio means taking on more debt, and higher debt levels can increase the financial risk for the firm. It doesn't necessarily mean that the firm has debts exceeding the value of its assets, but it does imply a higher risk of financial distress or insolvency, as the firm has more debt to service and potential fluctuations in earnings can have a magnified impact on its financial stability.