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FRM Part I · FRM Exam Part I · Corporate Bonds

A corporate bond indenture includes a negative pledge clause. Which of the following best describes the effect of this covenant on bondholders?

A negative pledge prevents the issuer from pledging assets to other lenders in ways that would weaken existing bondholders' position. It protects unsecured holders by keeping them at least equal to later creditors. It is not a call, conversion or sinking fund feature.

  1. AIt restricts the issuer from pledging its assets as security to other lenders in a way that would place existing bondholders in a weaker positionCorrect
  2. BIt gives the issuer the right to redeem the bond at par at any time
  3. CIt allows bondholders to convert the bond into the issuer's common shares
  4. DIt requires the issuer to set aside cash annually in a fund to retire the bonds

Explanation

A negative pledge is a restrictive covenant that limits the issuer from granting security over its assets to other creditors that would subordinate existing unsecured bondholders. Redemption rights describe call features, conversion describes convertible bonds, and cash set-asides describe sinking funds.

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