Question

9. What are bond covenants (give examples) and what role do restrictive covenants play in bond markets?

Answer 1

Answer-

Bond covenants are certain terms and conditions that both the borrowers and lenders should agree as part of issuance of bond.

Covenants are legally binding for the payment of debt obligation andreduces the ambiguity for debt holders.

These covenants are classified as Affirmative covenants and Restrictive or Negative covenants

Affirmative Covenants bind the borrower by certain actions like paying interest and principal intime and paying taxes , insuring pledged assets and maintaining financial ratios lik liquidity and solvency ratios.

Restritive or Negative covenants restricts the borrower like incurring additional debt on pledged assets or diecting cash flows to the shareholders of company in the form of dividends or share repurchases.

The restrictions on bond markets for investment grade bonds survives the financial crisis. The pre-crisis period reduction in yields is  60 to 72 basis points whereas the post crisis reduction in yields is 51 to 55 basis points.

The restrictions on bond markets in case of non investment grade bonds the pre crisis has insignificant effect on yields whereas the redution in yields post crisis is 141 to 150 basis points.