Final answer:
The more debt a firm has, the more risky it is due to fixed financial obligations of scheduled interest payments, which increase the firm's financial risk, especially if revenue falls short.
Step-by-step explanation:
The relationship between a firm's debt and its riskiness revolves around the financial leverage that debt provides. When a firm opts to access financial capital, it may borrow from a bank, issue bonds, or issue stock. Each choice carries distinct implications for the firm's operations, control, and financial risk. Borrowing through debt such as loans or bonds adds a fixed obligation in the form of scheduled interest payments, which the firm must honor irrespective of its income level. This increases the firm's financial risk because if the firm fails to generate enough revenue to cover its debt payments, it may face solvency issues.
On the other hand, issuing stock dilutes ownership and places the firm under the oversight of a board of directors and shareholders, but it does not involve a commitment to fixed payments and thus, brings a different type of risk related to market conditions and shareholder expectations.
Risk assessment in finance also considers factors like interest rate risk, the potential variability in the expected and actual rates of return, and the firm's liquidity. Firms with a high degree of leverage are deemed riskier because they are more vulnerable to shifts in market conditions that might affect their ability to meet debt obligations.