The covenant definition is a restrictive clause in a bond contract. The purpose of the clause is to protect the lender (the party that invests in the bond) by imposing restrictions on the borrower (the party that issues the bond). Furthermore, the covenant amounts to the lender agreeing to lend money to the borrower as long as certain financial performance criteria are met and maintained throughout the duration of the loan contract.
Covenants may cover criteria including the following:
- Levels of working capital
- Debt-equity ratios
- Dividend payments
- Other factors that can affect the borrower’s ability to repay loans
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