Joined: 13 Nov 2011
Online Status: Offline Posts: 28
Posted: 18 Dec 2011 at 05:14 | IP Logged
Does anyone please help me to understand this? I can't understand why the limit of debt increase interest rate on the bonds being sold?
Bisk 51-63 85
What would be the primary reason for a company to agree to a debt covenant limiting the percentage of its long-term debt?
a. To cause the price of the company's stock to rise b. To lower the company's bond rating c. To reduce the risk for existing bondholders d. To reduce the interest rate on the bonds being sold
The answer is d,
A debt covenant is a promise to debt holders. By promising to limit the percentage of its long-term debt, the debtor assures debt holders that, even in a period of economic strain, there will be sufficient resources to make interest payments. This risk reduction makes the debt more attractive than similar instruments with the same terms except for the debt covenant, making its cost (interest rate) lower.
Joined: 06 Dec 2011 Location: United States
Online Status: Offline Posts: 37
Posted: 19 Dec 2011 at 15:25 | IP Logged
Long term debts are given based on the security(assets) offered by the company. As asset values can diminish over a period time, lenders would like to secure their loans by restricting claims on the property by any other lenders.
In other words, lenders restrict the ability of the company to borrow further.
Joined: 13 Nov 2011
Online Status: Offline Posts: 28
Posted: 20 Dec 2011 at 06:23 | IP Logged
Dear Ramplacentia,
Thank you for your explanation. I got it!
Dear CPA 1979
I like Bisk more than Wiley. I started with Wiley first but the letter was too small so I changed to Bisk! It's very hard to read Wiley's letter because of the size of the font.But it's easier to carry Wiley because each section can be separated.
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Topic: BEC-Net present value
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