Certified Financial Management Specialist Practice Exam

What represents the risk of a borrower defaulting on loan repayment?

1. Market Risk

2. Liquidity Risk

3. Reputational Risk

4. Operational Risk

The correct answer is: Market Risk

The situation described in the question pertains to the specific risk associated with a borrower failing to meet their loan repayment obligations. This situation is specifically captured by credit risk, which reflects the likelihood of a borrower defaulting on their debt. Market risk, while relevant to the investment landscape, pertains to the potential losses due to market fluctuations, such as changes in stock prices or interest rates, rather than borrower behavior. Liquidity risk involves the challenges of converting assets to cash quickly without a significant drop in value, which is also distinct from the borrower's default scenario. Reputational risk relates to the loss of stakeholder confidence due to negative publicity or action affecting an organization, which doesn't specifically pertain to the borrower defaulting on loans. Operational risk refers to potential losses resulting from inadequate or failed internal processes, systems, or external events. It does not directly address the specific risk of a borrower failing to repay a loan. Therefore, the correct concept that captures the risk of a borrower defaulting on loan repayment would be credit risk, which is not among the provided options, but understanding these differentiations helps in grasping the broader financial risk framework.