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hello sir..
Q;When issuing new loan notes What would be the primary reason for a debt covenant limiting the firm future level of DEBT??1)To Lower the company credit Rating.
2)To reduce the coupon rate..i think 1 is correct because its true because its restrict company to introduce more debt otherwise credit rating is lower due to increase inWACC..
But i am surprised to see that actually 2 is correct by giving reason
A debt covenant is a provision in a loan note indenture that the loan note issuer will either do or not do certain things..Sir you dont think the REASON (PROVISION) is not written in above Question thats why question is not clear what they want..
Sir if this type of question is come in real exams which is not clear then how we overcome with this type of questions..
Also plz plz explain why 1 is wrong and 2 is correct…
I think you are mis-reading the question.
They are not asking why a debt covenant limits future debt – a debt covenant is always likely to do that.
It is asking what the reason for having a debt covenant is in the first place.It may have the affect of changing the credit rating, but this is not the reason for having the covenant.
The reason for having it is to make the debt less risky for investors (because they are limiting the extra they will raise) and therefore the investors will accept lower interest.
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