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CFA Level I · CFA Level I Exam · Topics in Long-Term Liabilities and Equity

A borrower's loan agreement includes an affirmative covenant and a negative covenant. Which of the following is the best example of a negative covenant?

Limiting dividend payments is a negative covenant. Negative covenants restrict borrower actions such as dividends, extra borrowing or asset sales, whereas affirmative covenants require actions like maintaining insurance or providing audited financial statements to lenders.

  1. AMaintaining insurance on pledged assets
  2. BDelivering audited financial statements annually
  3. CLimiting dividend payments to a set percentage of net incomeCorrect

Explanation

Negative covenants restrict actions the borrower may take, such as capping dividends, limiting additional debt or restricting asset sales. Insurance and delivering audited statements are actions the borrower must perform, so they are affirmative covenants.

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