Which of the following common debt covenants best describes an affirmative covenant?
- Restricting future borrowings
- Prohibiting financial ratios from falling below specified levels
- Limiting dividend payments
B is correct. pls explain
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Affirmative covenant may be termed as certain terms which the borrower promises to fulfill. If the financial ratios are pre defined by the lender to the borrower which acts as a protection for the lender. Other two options are restrictive in nature.
Covenants are some terms which are laid down prior in any contract or advances and which are to be fulfiled.
Now there are two way either Affirmative/positive ki ha yeh hona accha hain aur aisa karna chaiye. Negative are jo restrictive hain kafi.
In above question, future borrowing na ho aur dividend payments ki na ho yeh positive hain kyuki firstly company should release itself from existing debt.
but prohibit karna force dena ki yeh ratio itna hi ho yeh negative hain, ho sakta hain ki ratio kisi valid reason se hil jaye so it is not that good. yaad rakhna jo b cheez kafi restrictive lage ya negative lage voh negative covenant.
I believe that option 2, i.e. maintaining certain ratios is affirmative in nature. The reason being, this is not restricting the business from making any decisions. Whereas in A and C, it is limiting the business from borrowing and from giving out dividends.