If a company has high gearing, what is the likely implication for risk and credit metrics?

• A. If gearing is high, equity increases and risk falls.
• B. High gearing increases leverage and risk, affecting interest coverage and solvency.
• C. High gearing reduces debt and improves liquidity.
• D. Gearing has no impact on risk.

Answer: (B)

High gearing means a company uses a large amount of debt relative to equity, increasing financial leverage. That higher leverage raises risk because debt comes with fixed interest payments that must be paid even if profits are down. When earnings are volatile, interest obligations can strain cash flow, making the interest coverage ratio worse and pushing solvency measures like debt-to-equity higher. So gearing tends to amplify risk and negatively affect credit metrics. The other ideas—equity rising with high debt, debt being reduced, or no impact on risk—don’t fit how gearing works, since more debt doesn’t boost equity, it increases debt burden, and it does influence risk and lenders’ measures.