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CFA Level I · CFA Level I Exam · Fixed-Income Instrument Features

A bond indenture includes a covenant that limits the issuer's ability to take on additional debt. This covenant is best described as:

It is a negative covenant. Negative covenants restrict what the issuer may do, such as taking on more debt, so bondholders' claims are not diluted. Affirmative covenants instead require the issuer to perform certain actions, and a debt limit has nothing to do with early redemption.

  1. Aan affirmative covenant, because it requires the issuer to maintain its credit rating
  2. Ba negative covenant, because it restricts the issuer's actions to protect bondholdersCorrect
  3. Ca call provision, because it lets the issuer retire debt before maturity

Explanation

Negative covenants prohibit or restrict actions such as issuing more debt, paying excessive dividends or selling assets. Affirmative covenants require actions like paying interest and maintaining insurance. A debt limit is not a call provision.

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