CFA Practice Question
Which one of the following statements regarding debt covenants is false?
B. Negative covenants (e.g., you are not permitted to pay out annual dividends in excess of 30% of net earnings) tend to play a less significant role in loan agreements than do affirmative covenants.
C. A creditor (lender) would prefer a higher fixed charge coverage ratio to a lower value.
D. Maintaining adequate insurance on assets serving as collateral in loan agreements is an example of an affirmative covenant.
A. The term "technical default" is used to describe a situation where the debtor has violated one or more covenants in a loan agreement but continues to make all payments on a timely basis.
B. Negative covenants (e.g., you are not permitted to pay out annual dividends in excess of 30% of net earnings) tend to play a less significant role in loan agreements than do affirmative covenants.
C. A creditor (lender) would prefer a higher fixed charge coverage ratio to a lower value.
D. Maintaining adequate insurance on assets serving as collateral in loan agreements is an example of an affirmative covenant.
Correct Answer: B
This statement is false. Negative covenants place direct restrictions on management actions and thus play a more significant role than affirmative covenants in loan agreements.
User Contributed Comments 4
| User | Comment |
|---|---|
| udhay | what is fixed charge coverage ratio |
| nwarrior | The firm's ratio in regards to being able to pay their fixed charges. |
| HolzGe1 | fixed charge coverage ratio = (EBIT + lease payments) / (interest expense + lease payments) |
| khalifa92 | all negative covenants play a bigger role |