Debt covenants in some cases limit borrower’s ability in financial decision making. Can you think of...

Debt covenants in some cases limit borrower’s ability in financial decision making. Can you think of any such covenant and discuss its importance?

Expert Solution

Debt covenants are certain restriction imposted on the borrowers in the contract . The purpose of debt cevenants is to protect the interest of the creditors.Though it helps borrowers by reducing cost of borrowing, these in some cases limit borrower's ability to take decisions.

For example , an affirmative covenant requiring the borrower to maintain its current ratio above some lower limit. This will restrict borrower's decision to increase current liability or decrease current assets.

There may be negative covenants like restriction to invest or pay dividends.

List of covenants generally found that limits borrowers ability in financial decision making are given below:

Restriction on future borrowings
Restriction on investments
Limiting the dividends
Restrictions on level of financial ratios like debt equity or current ratio
Limitation on Mergers and Acquisitions
Limitation on asset sale

jeff jeffy answered 1 year ago

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