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Covenants are actions which the issuer commits to take (in case of affirmative/positive covenants) or not (in case of negative covenants).
Affirmative covenants are typically administrative in nature; they list what issuer would do with cash proceeds from bond issues, comply with laws and regulations, maintain current lines of business, etc. Negative covenants differ from affirmative covenants in that they restrict the issuer’s business actions. They are meant to protect bondholders from dilution of their claim, asset withdrawals/substitutions, and suboptimal investments.
Examples of negative covenants include:
The above list is not exhaustive. The main purpose of the negative covenants is to make sure that the issuer honors its obligations to the bondholders, but they should not be too restrictive because otherwise, they could force the issuer to default when the default is avoidable.
by Obaidullah Jan, ACA, CFA on Mon Feb 17 2020
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