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The govt of Country X plans to increase the bank lending rate significantly which can negatively impact on highly geared businesses, the associated financial risk can be identified as:
political or gearing risk?
My ans – Political Risk – Is this correct?
It is a gearing risk as that is how the effect is felt ie potentially not being able to pay interest.. Political risk is usually regarded as something to do with international relations, unrest, changes in government spending policies etc.
However it is the govt of Ctry X who have increase the bank lending rate considerably, I was not sure if this was a trick question.
Isn’t gearing risk the risk associated with high debt levels in relation to equity and not so much to do increases in interest rates? Just wanted more clarity. Thank you.
But the reason high gearing is an issue is that interest rates might rise. Think of it this way: if the company had no borrowings the government could raise interest rate to very high levels and the company would suffer no risk. So the problem is not political action – it is borrowing,
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