2. Debt Covenants

Question 1

Debt is divided into

Answer 1

Senior debt and subordinated (junior) debt

Question 2

A typical loan agreement has the following things

Answer 2

• The Note: the amount, interest and timing of repayment;
• Collateral: specifies assets assigned and terms under which lender takes possession of assets;
• Covenant
• Borrower Guarantees: guarantees for the lender if the borrower defaults;
• Event of Default: conditions under which a loan is considered in default.

Question 3

Debt covenant definition

Answer 3

A debt covenant is an agreement between a company and its creditor that the company should operate between “certain limits”.

Question 4

“Certain Limits” of a covenant

Answer 4

• sets restrictions to the lender such that the lender doesn’t take the money and invest it in useless things
• also sets rules what to do if the lender breaches the covenant

Question 5

Paper - Roberts and Sufi

The probability of violating a covenant is decreasing when ..

Answer 5

when the firm has a higher credit rating

Question 6

Paper - Roberts and Sufi

What happens with the debt of a firm after the violation?

Answer 6

The debt of a firm decreases after a violation

Question 7

Paper - Roberts and Sufi

Firms with a higher leverage ratio experience ..

Answer 7

higher declines in net debt issuance

Question 8

Paper - Roberts and Sufi

Firms with less alternative sources of capital ..

Answer 8

experienced the highest drop in net debt issuance

Question 9

Paper - Roberts and Sufi

It is more likely that the creditor takes action if ..

Answer 9

o The firm is a serial offender
o The firm is highly leveraged
o The firm does not have much cash
o The firm does not perform well
o The firm does not have a credit rating