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A firm’s default risk, the measurement of the chances of the event in which the company will be unable to make the required payments on its debt obligations, reflects not only the likelihood that the firm will have bad luck but also the risk that the firm’s managerial decisions will lead the firm to default. Such management risk occurs because the impact of management on the firm’s value is uncertain, and this uncertainty affects the market’s perception of a firm’s risk.  Uncertainty about management is likely to be the highest when there is a new management team and should decrease over time as management’s ability becomes known more precisely. In particular, when the new CEO is not considered an “heir apparent” prior to getting the position, or when he comes from outside of the company, or when the new CEO is younger, the market is expected to perceive relatively high uncertainty about the CEO’s ability or future actions. Accordingly, it comes as no surprise that the CDS spread, a measure of a firm’s expected default risk, is about 35 basis points higher when a new CEO takes office than three years into his tenure. The CEO, however, is not the only member of the management team who is relevant for decision making in the firm. Chief Financial Officers (CFOs) have a large role in financial decision-making, so uncertainty about new CFOs could also affect the firm’s default risk and cost of borrowing.
Now, a central feature of financial markets is that the interest rate a firm pays on debt increases with an increase in the market’s perception of the firm’s risk. This risk occurs because of factors that affect the value of the firm’s underlying assets and because of uncertainty about how these assets will be managed. The literature on debt pricing typically does not distinguish between these types of underlying risks. However, all risks, including those generated by uncertainty about management, affect the likelihood of default. Consequently, a rational market should incorporate managerial-generated uncertainty into its assessment of a firm’s risk when pricing its securities. Also since uncertainty about management affects firms’ costs of borrowing and consequently their financial policies, the value of maintaining transparency in managerial policies and communicating them to the marketplace should be realised.
Which of the following CANNOT be inferred from the passage?
  • a)
    Market’s perception of firm’s risk is minimal when the new CEO is an “heir apparent” or is from within the existing management team.
  • b)
    The uncertainty regarding a new CEO is likely to be more in the first years of his tenure than in the fourth year.
  • c)
    The default risk of a firm represents more than one thing about the firm.
  • d)
    It is unusual for a piece of literature on debt pricing to differentiate between the risk generated from the factors affecting a firm’s asset and one generated from how these assets will be managed.
  • e)
    Uncertainty about management affects a firm’s financial policies.
Correct answer is option 'A'. Can you explain this answer?
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A firm’s default risk, the measurement of the chances of the eve...
Passage Analysis
Summary and Main Point
 
This is an Inference EXCEPT question. Four out of the five given answer choices CAN be deduced from the passage; these choice are INCORRECT. The correct answer will either be inconsistent with the given information or be something for which there is no supporting information in the passage.
Answer Choices
A
Market’s perception of firm’s risk is minimal when the new CEO is an “heir apparent” or is from within the existing management team.
Correct
First of all, a firm’s risk is a combination of management related and other risks. So, we cannot draw a sweeping statement about a firm’s risk by estimating just management related risk. Secondly, there is no given information to support that management related risk will be “minimal” under the given circumstances.
B
The uncertainty regarding a new CEO is likely to be more in the first years of his tenure than in the fourth year.
Incorrect: Can be Inferred
The author gives us enough throughout the passage to conclude the information given in this choice. For specific mention, one could refer to the following portion:
Accordingly, it comes as no surprise that the CDS spread, a measure of a firm’s expected default risk, is about 35 basis points higher when a new CEO takes office than three years into his tenure.
C
The default risk of a firm represents more than one thing about the firm.
Incorrect: Can be Inferred
This statement can be inferred from the first sentence of the passage.
D
It is unusual for a piece of literature on debt pricing to differentiate between the risk generated from the factors affecting a firm’s asset and one generated from how these assets will be managed.
Incorrect: Can be Inferred
We can infer the information given in this choice from the following portion:
The literature on debt pricing typically does not distinguish between these types of underlying risks.
E
Uncertainty about management affects a firm’s financial policies.
Incorrect: Can be Inferred
This can be deuced from the following section in the second paragraph:
Also since uncertainty about management affects firms’ costs of borrowing and consequently their financial policies…
We can conclude from the above portion that the uncertainty affects the cost of borrowing, which in turn affects the financial policies of the firm.
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A firms default risk, the measurement of the chances of the event in which the company will be unable to make the required payments on its debt obligations, reflects not only the likelihood that the firm will have bad luck but also the risk that the firms managerial decisions will lead the firm to default. Such management risk occurs because the impact of management on the firms value is uncertain, and this uncertainty affects the markets perception of a firms risk. Uncertainty about management is likely to be the highest when there is a new management team and should decrease over time as managements ability becomes known more precisely. In particular, when the new CEO is not considered an heir apparent prior to getting the position, or when he comes from outside of the company, or when the new CEO is younger, the market is expected to perceive relatively high uncertainty about the CEOs ability or future actions. Accordingly, it comes as no surprise that the CDS spread, a measure of a firms expected default risk, is about 35 basis points higher when a new CEO takes office than three years into his tenure. The CEO, however, is not the only member of the management team who is relevant for decision making in the firm. Chief Financial Officers (CFOs) have a large role in financial decision-making, so uncertainty about new CFOs could also affect the firms default risk and cost of borrowing.Now, a central feature of financial markets is that the interest rate a firm pays on debt increases with an increase in the markets perception of the firms risk. This risk occurs because of factors that affect the value of the firms underlying assets and because of uncertainty about how these assets will be managed. The literature on debt pricing typically does not distinguish between these types of underlying risks. However, all risks, including those generated by uncertainty about management, affect the likelihood of default. Consequently, a rational market should incorporate managerial-generated uncertainty into its assessment of a firms risk when pricing its securities. Also since uncertainty about management affects firms costs of borrowing and consequently their financial policies, the value of maintaining transparency in managerial policies and communicating them to the marketplace should be realised.Which of the following statements would the author most likely agree with?

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A firm’s default risk, the measurement of the chances of the event in which the company will be unable to make the required payments on its debt obligations, reflects not only the likelihood that the firm will have bad luck but also the risk that the firm’s managerial decisions will lead the firm to default. Such management risk occurs because the impact of management on the firm’s value is uncertain, and this uncertainty affects the market’s perception of a firm’s risk. Uncertainty about management is likely to be the highest when there is a new management team and should decrease over time as management’s ability becomes known more precisely. In particular, when the new CEO is not considered an “heir apparent” prior to getting the position, or when he comes from outside of the company, or when the new CEO is younger, the market is expected to perceive relatively high uncertainty about the CEO’s ability or future actions. Accordingly, it comes as no surprise that the CDS spread, a measure of a firm’s expected default risk, is about 35 basis points higher when a new CEO takes office than three years into his tenure. The CEO, however, is not the only member of the management team who is relevant for decision making in the firm. Chief Financial Officers (CFOs) have a large role in financial decision-making, so uncertainty about new CFOs could also affect the firm’s default risk and cost of borrowing.Now, a central feature of financial markets is that the interest rate a firm pays on debt increases with an increase in the market’s perception of the firm’s risk. This risk occurs because of factors that affect the value of the firm’s underlying assets and because of uncertainty about how these assets will be managed. The literature on debt pricing typically does not distinguish between these types of underlying risks. However, all risks, including those generated by uncertainty about management, affect the likelihood of default. Consequently, a rational market should incorporate managerial-generated uncertainty into its assessment of a firm’s risk when pricing its securities. Also since uncertainty about management affects firms’ costs of borrowing and consequently their financial policies, the value of maintaining transparency in managerial policies and communicating them to the marketplace should be realised.Which of the following CANNOT be inferred from the passage?a)Market’s perception of firm’s risk is minimal when the new CEO is an “heir apparent” or is from within the existing management team.b)The uncertainty regarding a new CEO is likely to be more in the first years of his tenure than in the fourth year.c)The default risk of a firm represents more than one thing about the firm.d)It is unusual for a piece of literature on debt pricing to differentiate between the risk generated from the factors affecting a firm’s asset and one generated from how these assets will be managed.e)Uncertainty about management affects a firm’s financial policies.Correct answer is option 'A'. Can you explain this answer?
Question Description
A firm’s default risk, the measurement of the chances of the event in which the company will be unable to make the required payments on its debt obligations, reflects not only the likelihood that the firm will have bad luck but also the risk that the firm’s managerial decisions will lead the firm to default. Such management risk occurs because the impact of management on the firm’s value is uncertain, and this uncertainty affects the market’s perception of a firm’s risk. Uncertainty about management is likely to be the highest when there is a new management team and should decrease over time as management’s ability becomes known more precisely. In particular, when the new CEO is not considered an “heir apparent” prior to getting the position, or when he comes from outside of the company, or when the new CEO is younger, the market is expected to perceive relatively high uncertainty about the CEO’s ability or future actions. Accordingly, it comes as no surprise that the CDS spread, a measure of a firm’s expected default risk, is about 35 basis points higher when a new CEO takes office than three years into his tenure. The CEO, however, is not the only member of the management team who is relevant for decision making in the firm. Chief Financial Officers (CFOs) have a large role in financial decision-making, so uncertainty about new CFOs could also affect the firm’s default risk and cost of borrowing.Now, a central feature of financial markets is that the interest rate a firm pays on debt increases with an increase in the market’s perception of the firm’s risk. This risk occurs because of factors that affect the value of the firm’s underlying assets and because of uncertainty about how these assets will be managed. The literature on debt pricing typically does not distinguish between these types of underlying risks. However, all risks, including those generated by uncertainty about management, affect the likelihood of default. Consequently, a rational market should incorporate managerial-generated uncertainty into its assessment of a firm’s risk when pricing its securities. Also since uncertainty about management affects firms’ costs of borrowing and consequently their financial policies, the value of maintaining transparency in managerial policies and communicating them to the marketplace should be realised.Which of the following CANNOT be inferred from the passage?a)Market’s perception of firm’s risk is minimal when the new CEO is an “heir apparent” or is from within the existing management team.b)The uncertainty regarding a new CEO is likely to be more in the first years of his tenure than in the fourth year.c)The default risk of a firm represents more than one thing about the firm.d)It is unusual for a piece of literature on debt pricing to differentiate between the risk generated from the factors affecting a firm’s asset and one generated from how these assets will be managed.e)Uncertainty about management affects a firm’s financial policies.Correct answer is option 'A'. Can you explain this answer? for GMAT 2024 is part of GMAT preparation. The Question and answers have been prepared according to the GMAT exam syllabus. Information about A firm’s default risk, the measurement of the chances of the event in which the company will be unable to make the required payments on its debt obligations, reflects not only the likelihood that the firm will have bad luck but also the risk that the firm’s managerial decisions will lead the firm to default. Such management risk occurs because the impact of management on the firm’s value is uncertain, and this uncertainty affects the market’s perception of a firm’s risk. Uncertainty about management is likely to be the highest when there is a new management team and should decrease over time as management’s ability becomes known more precisely. In particular, when the new CEO is not considered an “heir apparent” prior to getting the position, or when he comes from outside of the company, or when the new CEO is younger, the market is expected to perceive relatively high uncertainty about the CEO’s ability or future actions. Accordingly, it comes as no surprise that the CDS spread, a measure of a firm’s expected default risk, is about 35 basis points higher when a new CEO takes office than three years into his tenure. The CEO, however, is not the only member of the management team who is relevant for decision making in the firm. Chief Financial Officers (CFOs) have a large role in financial decision-making, so uncertainty about new CFOs could also affect the firm’s default risk and cost of borrowing.Now, a central feature of financial markets is that the interest rate a firm pays on debt increases with an increase in the market’s perception of the firm’s risk. This risk occurs because of factors that affect the value of the firm’s underlying assets and because of uncertainty about how these assets will be managed. The literature on debt pricing typically does not distinguish between these types of underlying risks. However, all risks, including those generated by uncertainty about management, affect the likelihood of default. Consequently, a rational market should incorporate managerial-generated uncertainty into its assessment of a firm’s risk when pricing its securities. Also since uncertainty about management affects firms’ costs of borrowing and consequently their financial policies, the value of maintaining transparency in managerial policies and communicating them to the marketplace should be realised.Which of the following CANNOT be inferred from the passage?a)Market’s perception of firm’s risk is minimal when the new CEO is an “heir apparent” or is from within the existing management team.b)The uncertainty regarding a new CEO is likely to be more in the first years of his tenure than in the fourth year.c)The default risk of a firm represents more than one thing about the firm.d)It is unusual for a piece of literature on debt pricing to differentiate between the risk generated from the factors affecting a firm’s asset and one generated from how these assets will be managed.e)Uncertainty about management affects a firm’s financial policies.Correct answer is option 'A'. Can you explain this answer? covers all topics & solutions for GMAT 2024 Exam. Find important definitions, questions, meanings, examples, exercises and tests below for A firm’s default risk, the measurement of the chances of the event in which the company will be unable to make the required payments on its debt obligations, reflects not only the likelihood that the firm will have bad luck but also the risk that the firm’s managerial decisions will lead the firm to default. Such management risk occurs because the impact of management on the firm’s value is uncertain, and this uncertainty affects the market’s perception of a firm’s risk. Uncertainty about management is likely to be the highest when there is a new management team and should decrease over time as management’s ability becomes known more precisely. In particular, when the new CEO is not considered an “heir apparent” prior to getting the position, or when he comes from outside of the company, or when the new CEO is younger, the market is expected to perceive relatively high uncertainty about the CEO’s ability or future actions. Accordingly, it comes as no surprise that the CDS spread, a measure of a firm’s expected default risk, is about 35 basis points higher when a new CEO takes office than three years into his tenure. The CEO, however, is not the only member of the management team who is relevant for decision making in the firm. Chief Financial Officers (CFOs) have a large role in financial decision-making, so uncertainty about new CFOs could also affect the firm’s default risk and cost of borrowing.Now, a central feature of financial markets is that the interest rate a firm pays on debt increases with an increase in the market’s perception of the firm’s risk. This risk occurs because of factors that affect the value of the firm’s underlying assets and because of uncertainty about how these assets will be managed. The literature on debt pricing typically does not distinguish between these types of underlying risks. However, all risks, including those generated by uncertainty about management, affect the likelihood of default. Consequently, a rational market should incorporate managerial-generated uncertainty into its assessment of a firm’s risk when pricing its securities. Also since uncertainty about management affects firms’ costs of borrowing and consequently their financial policies, the value of maintaining transparency in managerial policies and communicating them to the marketplace should be realised.Which of the following CANNOT be inferred from the passage?a)Market’s perception of firm’s risk is minimal when the new CEO is an “heir apparent” or is from within the existing management team.b)The uncertainty regarding a new CEO is likely to be more in the first years of his tenure than in the fourth year.c)The default risk of a firm represents more than one thing about the firm.d)It is unusual for a piece of literature on debt pricing to differentiate between the risk generated from the factors affecting a firm’s asset and one generated from how these assets will be managed.e)Uncertainty about management affects a firm’s financial policies.Correct answer is option 'A'. Can you explain this answer?.
Solutions for A firm’s default risk, the measurement of the chances of the event in which the company will be unable to make the required payments on its debt obligations, reflects not only the likelihood that the firm will have bad luck but also the risk that the firm’s managerial decisions will lead the firm to default. Such management risk occurs because the impact of management on the firm’s value is uncertain, and this uncertainty affects the market’s perception of a firm’s risk. Uncertainty about management is likely to be the highest when there is a new management team and should decrease over time as management’s ability becomes known more precisely. In particular, when the new CEO is not considered an “heir apparent” prior to getting the position, or when he comes from outside of the company, or when the new CEO is younger, the market is expected to perceive relatively high uncertainty about the CEO’s ability or future actions. Accordingly, it comes as no surprise that the CDS spread, a measure of a firm’s expected default risk, is about 35 basis points higher when a new CEO takes office than three years into his tenure. The CEO, however, is not the only member of the management team who is relevant for decision making in the firm. Chief Financial Officers (CFOs) have a large role in financial decision-making, so uncertainty about new CFOs could also affect the firm’s default risk and cost of borrowing.Now, a central feature of financial markets is that the interest rate a firm pays on debt increases with an increase in the market’s perception of the firm’s risk. This risk occurs because of factors that affect the value of the firm’s underlying assets and because of uncertainty about how these assets will be managed. The literature on debt pricing typically does not distinguish between these types of underlying risks. However, all risks, including those generated by uncertainty about management, affect the likelihood of default. Consequently, a rational market should incorporate managerial-generated uncertainty into its assessment of a firm’s risk when pricing its securities. Also since uncertainty about management affects firms’ costs of borrowing and consequently their financial policies, the value of maintaining transparency in managerial policies and communicating them to the marketplace should be realised.Which of the following CANNOT be inferred from the passage?a)Market’s perception of firm’s risk is minimal when the new CEO is an “heir apparent” or is from within the existing management team.b)The uncertainty regarding a new CEO is likely to be more in the first years of his tenure than in the fourth year.c)The default risk of a firm represents more than one thing about the firm.d)It is unusual for a piece of literature on debt pricing to differentiate between the risk generated from the factors affecting a firm’s asset and one generated from how these assets will be managed.e)Uncertainty about management affects a firm’s financial policies.Correct answer is option 'A'. Can you explain this answer? in English & in Hindi are available as part of our courses for GMAT. Download more important topics, notes, lectures and mock test series for GMAT Exam by signing up for free.
Here you can find the meaning of A firm’s default risk, the measurement of the chances of the event in which the company will be unable to make the required payments on its debt obligations, reflects not only the likelihood that the firm will have bad luck but also the risk that the firm’s managerial decisions will lead the firm to default. Such management risk occurs because the impact of management on the firm’s value is uncertain, and this uncertainty affects the market’s perception of a firm’s risk. Uncertainty about management is likely to be the highest when there is a new management team and should decrease over time as management’s ability becomes known more precisely. In particular, when the new CEO is not considered an “heir apparent” prior to getting the position, or when he comes from outside of the company, or when the new CEO is younger, the market is expected to perceive relatively high uncertainty about the CEO’s ability or future actions. Accordingly, it comes as no surprise that the CDS spread, a measure of a firm’s expected default risk, is about 35 basis points higher when a new CEO takes office than three years into his tenure. The CEO, however, is not the only member of the management team who is relevant for decision making in the firm. Chief Financial Officers (CFOs) have a large role in financial decision-making, so uncertainty about new CFOs could also affect the firm’s default risk and cost of borrowing.Now, a central feature of financial markets is that the interest rate a firm pays on debt increases with an increase in the market’s perception of the firm’s risk. This risk occurs because of factors that affect the value of the firm’s underlying assets and because of uncertainty about how these assets will be managed. The literature on debt pricing typically does not distinguish between these types of underlying risks. However, all risks, including those generated by uncertainty about management, affect the likelihood of default. Consequently, a rational market should incorporate managerial-generated uncertainty into its assessment of a firm’s risk when pricing its securities. Also since uncertainty about management affects firms’ costs of borrowing and consequently their financial policies, the value of maintaining transparency in managerial policies and communicating them to the marketplace should be realised.Which of the following CANNOT be inferred from the passage?a)Market’s perception of firm’s risk is minimal when the new CEO is an “heir apparent” or is from within the existing management team.b)The uncertainty regarding a new CEO is likely to be more in the first years of his tenure than in the fourth year.c)The default risk of a firm represents more than one thing about the firm.d)It is unusual for a piece of literature on debt pricing to differentiate between the risk generated from the factors affecting a firm’s asset and one generated from how these assets will be managed.e)Uncertainty about management affects a firm’s financial policies.Correct answer is option 'A'. Can you explain this answer? defined & explained in the simplest way possible. Besides giving the explanation of A firm’s default risk, the measurement of the chances of the event in which the company will be unable to make the required payments on its debt obligations, reflects not only the likelihood that the firm will have bad luck but also the risk that the firm’s managerial decisions will lead the firm to default. Such management risk occurs because the impact of management on the firm’s value is uncertain, and this uncertainty affects the market’s perception of a firm’s risk. Uncertainty about management is likely to be the highest when there is a new management team and should decrease over time as management’s ability becomes known more precisely. In particular, when the new CEO is not considered an “heir apparent” prior to getting the position, or when he comes from outside of the company, or when the new CEO is younger, the market is expected to perceive relatively high uncertainty about the CEO’s ability or future actions. Accordingly, it comes as no surprise that the CDS spread, a measure of a firm’s expected default risk, is about 35 basis points higher when a new CEO takes office than three years into his tenure. The CEO, however, is not the only member of the management team who is relevant for decision making in the firm. Chief Financial Officers (CFOs) have a large role in financial decision-making, so uncertainty about new CFOs could also affect the firm’s default risk and cost of borrowing.Now, a central feature of financial markets is that the interest rate a firm pays on debt increases with an increase in the market’s perception of the firm’s risk. This risk occurs because of factors that affect the value of the firm’s underlying assets and because of uncertainty about how these assets will be managed. The literature on debt pricing typically does not distinguish between these types of underlying risks. However, all risks, including those generated by uncertainty about management, affect the likelihood of default. Consequently, a rational market should incorporate managerial-generated uncertainty into its assessment of a firm’s risk when pricing its securities. Also since uncertainty about management affects firms’ costs of borrowing and consequently their financial policies, the value of maintaining transparency in managerial policies and communicating them to the marketplace should be realised.Which of the following CANNOT be inferred from the passage?a)Market’s perception of firm’s risk is minimal when the new CEO is an “heir apparent” or is from within the existing management team.b)The uncertainty regarding a new CEO is likely to be more in the first years of his tenure than in the fourth year.c)The default risk of a firm represents more than one thing about the firm.d)It is unusual for a piece of literature on debt pricing to differentiate between the risk generated from the factors affecting a firm’s asset and one generated from how these assets will be managed.e)Uncertainty about management affects a firm’s financial policies.Correct answer is option 'A'. Can you explain this answer?, a detailed solution for A firm’s default risk, the measurement of the chances of the event in which the company will be unable to make the required payments on its debt obligations, reflects not only the likelihood that the firm will have bad luck but also the risk that the firm’s managerial decisions will lead the firm to default. Such management risk occurs because the impact of management on the firm’s value is uncertain, and this uncertainty affects the market’s perception of a firm’s risk. Uncertainty about management is likely to be the highest when there is a new management team and should decrease over time as management’s ability becomes known more precisely. In particular, when the new CEO is not considered an “heir apparent” prior to getting the position, or when he comes from outside of the company, or when the new CEO is younger, the market is expected to perceive relatively high uncertainty about the CEO’s ability or future actions. Accordingly, it comes as no surprise that the CDS spread, a measure of a firm’s expected default risk, is about 35 basis points higher when a new CEO takes office than three years into his tenure. The CEO, however, is not the only member of the management team who is relevant for decision making in the firm. Chief Financial Officers (CFOs) have a large role in financial decision-making, so uncertainty about new CFOs could also affect the firm’s default risk and cost of borrowing.Now, a central feature of financial markets is that the interest rate a firm pays on debt increases with an increase in the market’s perception of the firm’s risk. This risk occurs because of factors that affect the value of the firm’s underlying assets and because of uncertainty about how these assets will be managed. The literature on debt pricing typically does not distinguish between these types of underlying risks. However, all risks, including those generated by uncertainty about management, affect the likelihood of default. Consequently, a rational market should incorporate managerial-generated uncertainty into its assessment of a firm’s risk when pricing its securities. Also since uncertainty about management affects firms’ costs of borrowing and consequently their financial policies, the value of maintaining transparency in managerial policies and communicating them to the marketplace should be realised.Which of the following CANNOT be inferred from the passage?a)Market’s perception of firm’s risk is minimal when the new CEO is an “heir apparent” or is from within the existing management team.b)The uncertainty regarding a new CEO is likely to be more in the first years of his tenure than in the fourth year.c)The default risk of a firm represents more than one thing about the firm.d)It is unusual for a piece of literature on debt pricing to differentiate between the risk generated from the factors affecting a firm’s asset and one generated from how these assets will be managed.e)Uncertainty about management affects a firm’s financial policies.Correct answer is option 'A'. Can you explain this answer? has been provided alongside types of A firm’s default risk, the measurement of the chances of the event in which the company will be unable to make the required payments on its debt obligations, reflects not only the likelihood that the firm will have bad luck but also the risk that the firm’s managerial decisions will lead the firm to default. Such management risk occurs because the impact of management on the firm’s value is uncertain, and this uncertainty affects the market’s perception of a firm’s risk. Uncertainty about management is likely to be the highest when there is a new management team and should decrease over time as management’s ability becomes known more precisely. In particular, when the new CEO is not considered an “heir apparent” prior to getting the position, or when he comes from outside of the company, or when the new CEO is younger, the market is expected to perceive relatively high uncertainty about the CEO’s ability or future actions. Accordingly, it comes as no surprise that the CDS spread, a measure of a firm’s expected default risk, is about 35 basis points higher when a new CEO takes office than three years into his tenure. The CEO, however, is not the only member of the management team who is relevant for decision making in the firm. Chief Financial Officers (CFOs) have a large role in financial decision-making, so uncertainty about new CFOs could also affect the firm’s default risk and cost of borrowing.Now, a central feature of financial markets is that the interest rate a firm pays on debt increases with an increase in the market’s perception of the firm’s risk. This risk occurs because of factors that affect the value of the firm’s underlying assets and because of uncertainty about how these assets will be managed. The literature on debt pricing typically does not distinguish between these types of underlying risks. However, all risks, including those generated by uncertainty about management, affect the likelihood of default. Consequently, a rational market should incorporate managerial-generated uncertainty into its assessment of a firm’s risk when pricing its securities. Also since uncertainty about management affects firms’ costs of borrowing and consequently their financial policies, the value of maintaining transparency in managerial policies and communicating them to the marketplace should be realised.Which of the following CANNOT be inferred from the passage?a)Market’s perception of firm’s risk is minimal when the new CEO is an “heir apparent” or is from within the existing management team.b)The uncertainty regarding a new CEO is likely to be more in the first years of his tenure than in the fourth year.c)The default risk of a firm represents more than one thing about the firm.d)It is unusual for a piece of literature on debt pricing to differentiate between the risk generated from the factors affecting a firm’s asset and one generated from how these assets will be managed.e)Uncertainty about management affects a firm’s financial policies.Correct answer is option 'A'. Can you explain this answer? theory, EduRev gives you an ample number of questions to practice A firm’s default risk, the measurement of the chances of the event in which the company will be unable to make the required payments on its debt obligations, reflects not only the likelihood that the firm will have bad luck but also the risk that the firm’s managerial decisions will lead the firm to default. Such management risk occurs because the impact of management on the firm’s value is uncertain, and this uncertainty affects the market’s perception of a firm’s risk. Uncertainty about management is likely to be the highest when there is a new management team and should decrease over time as management’s ability becomes known more precisely. In particular, when the new CEO is not considered an “heir apparent” prior to getting the position, or when he comes from outside of the company, or when the new CEO is younger, the market is expected to perceive relatively high uncertainty about the CEO’s ability or future actions. Accordingly, it comes as no surprise that the CDS spread, a measure of a firm’s expected default risk, is about 35 basis points higher when a new CEO takes office than three years into his tenure. The CEO, however, is not the only member of the management team who is relevant for decision making in the firm. Chief Financial Officers (CFOs) have a large role in financial decision-making, so uncertainty about new CFOs could also affect the firm’s default risk and cost of borrowing.Now, a central feature of financial markets is that the interest rate a firm pays on debt increases with an increase in the market’s perception of the firm’s risk. This risk occurs because of factors that affect the value of the firm’s underlying assets and because of uncertainty about how these assets will be managed. The literature on debt pricing typically does not distinguish between these types of underlying risks. However, all risks, including those generated by uncertainty about management, affect the likelihood of default. Consequently, a rational market should incorporate managerial-generated uncertainty into its assessment of a firm’s risk when pricing its securities. Also since uncertainty about management affects firms’ costs of borrowing and consequently their financial policies, the value of maintaining transparency in managerial policies and communicating them to the marketplace should be realised.Which of the following CANNOT be inferred from the passage?a)Market’s perception of firm’s risk is minimal when the new CEO is an “heir apparent” or is from within the existing management team.b)The uncertainty regarding a new CEO is likely to be more in the first years of his tenure than in the fourth year.c)The default risk of a firm represents more than one thing about the firm.d)It is unusual for a piece of literature on debt pricing to differentiate between the risk generated from the factors affecting a firm’s asset and one generated from how these assets will be managed.e)Uncertainty about management affects a firm’s financial policies.Correct answer is option 'A'. Can you explain this answer? tests, examples and also practice GMAT tests.
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