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State the different types of bond covenants which bondholders may impose on shareholders to protect themselves.

      

State the different types of bond covenants which bondholders may impose on shareholders to protect themselves.

  

Answers


Kavungya
Bond covenants might include:
(i) An asset covenant. This would govern the company's acquisition, use
and disposal of assets. This could be for specified types of assets, or assets in
general.
(ii) Financing covenant. This covenant often defines the type and amount of
additional debt that the company can issue, and its ranking and potential claim
on assets in case of future default.
(iii) Dividend covenant. A dividend restricts the amount of dividend that the
company is able to pay. Such covenants might also be extended to share
repurchases.
(iv) Financial ratio covenants, fixing the limit of key ratios such as the gearing level,
interest cover, net working capital, or a minimum ratio of tangible assets to
total debt.
(v) Merger covenant, restricting future merger activity of the company.
(vi) Investment covenant, concerned with the company's future investment policy.
(vii) Sinking fund covenant whereby the company makes payments, typically to the
bond trustees, who might gradually repurchase bonds in the open market, or
build up a fund to redeem bonds.
There will often also be a „bonding covenant? that describes the mechanisms
by which the above covenants are to be monitored and enforced. This often includes
an independent audit and the appointment of a trustee representing the interests of the
bondholders.
From the company's perspective the major disadvantages of covenants is that they
restrict the freedom of action of the managers, and could prevent viable investments, or
mergers from occurring. They also necessitate monitoring and other costs. However,
covenants are also of value to companies. Without covenants the company might not be
able to raise as much funds in the form of debt, as lenders would not be prepared to
take the risk. Even if lenders were to take the risk they would require a higher default
premium (higher interest rates) in order to compensate for the risk. The existence of
covenants therefore reduces the cost of borrowing from a company.
Kavungya answered the question on December 15, 2021 at 07:53


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