Which of the following are negative protective covenants that can be found in a bond indenture?
I. Bond proceeds must be used to finance fixed assets
II. Bonds with senior status cannot be issued while this bond issue is outstanding
III. The issuer is prohibited from guaranteeing debt of another firm
IV. The issuer must furnish audited financial statements on an annual basis

Question

Quizplus · Accepted Answer

Negative protective covenants are restrictions on the actions of the issuer that aim at protecting the bondholders. Choice I is a positive protective covenant because it requires the issuer to use the bond proceeds in a specific way that can reduce the risk of default. Choice IV is a routine requirement for most bond issues, which is aimed at giving transparency to the bondholders. On the other hand, Choices II and III are negative covenants because they restrict the issuer from taking certain actions that may increase its risk of default or affect the bondholders' interests. Bonds with senior status may have priority over this bond issue in terms of claims on assets in case of default, which can decrease the bondholders' recovery rate. By prohibiting the issuer from guaranteeing the debt of another firm, the bondholders' exposure to the counterparty risk of other borrowers is reduced.

Which of the Following Are Negative Protective Covenants That Can