Chartered Financial Analyst (CFA) Level 1 Practice Exam 2025 - Free CFA Level 1 Practice Questions and Study Guide

High leverage refers to the use of borrowed funds to finance investments, which can amplify both returns and risks. The correct choice highlights a significant risk associated with high leverage: the potential inability to meet fixed financial obligations during economic downturns.

When a company or individual uses high leverage, they commit a substantial amount of borrowed money to their operations or investments. While this can lead to increased earnings when times are good, it also creates a burden during periods of economic stress. If cash flows decline due to lower revenues, the entity may struggle to meet its fixed obligations, such as interest payments on debt or loan repayments. This inability can lead to financial distress or even bankruptcy, as the leverage works against them in adverse conditions.

The other choices present an overly optimistic view of leverage without considering its risks. Some suggest that high leverage guarantees increased earnings or profits, which is misleading; leverage introduces variability and potential for losses as well. Similarly, the idea that leverage decreases bankruptcy risk contradicts the fundamental risk associated with high levels of debt, as it can make a company more vulnerable in tough economic times.