What is one risk associated with leveraged finance?

The correct answer highlights a key characteristic of leveraged finance, which involves using borrowed funds to amplify investment potential. This strategy increases the total capital available to a company or investment vehicle, but it also introduces higher levels of debt. As a result, a firm utilizing leveraged finance becomes more susceptible to market fluctuations because changes in interest rates, economic conditions, or industry-specific events can significantly affect its ability to meet debt obligations.

In times of economic downturn, for instance, revenue may decline sharply, making it difficult for a leveraged entity to service its debt. Moreover, the cost of debt financing can rise, increasing interest payments and further straining financial stability. Therefore, the inherent risk in leveraged finance is tied to this heightened vulnerability to both macroeconomic and microeconomic shifts in the market.

The other options describe attributes that do not align with the fundamental nature of leveraged finance. Lower interest expenses are typically not associated with leveraging, as higher risk usually results in higher borrowing costs. The claim of guaranteed returns is misleading, as leveraged investments carry substantial risk, and returns are never assured. Lastly, the notion of having no need to repay the principal is fundamentally incorrect within the context of any financial borrowing arrangement; repayment of principal is a basic characteristic of financing.