Editing Openai/68df4a3a-428c-8013-a459-5cff8e17edde (section)

=== Assistant: Excellent question! ===
Excellent question! Let’s break it down simply but clearly.

==== Protective covenants are rules written into a bond indenture to protect the interests of bondholders (the investors lending money). ====

They act like safeguards that limit what the issuing company can or cannot do while the bond is outstanding.

==== They mainly protect bondholders by reducing the risk that the company will take actions that make it harder to repay its debt. ====

Specifically, they protect against:
# Excessive Risk-Taking - Companies might be tempted to borrow more or take risky projects since bondholders bear much of the downside risk. - Covenants prevent reckless behavior that could endanger repayment.
# Asset Stripping - Without restrictions, a company could sell off valuable assets (collateral), making bonds less secure.
# Dilution of Bondholder Claims - Covenants can restrict issuing new debt that would rank equal or higher in priority, protecting existing bondholders’ position.
# Cash Flow Drain - Limits on dividend payments or share buybacks ensure the company doesn’t give too much cash to shareholders instead of servicing debt.
# Financial Health - Financial covenants (like maintaining a certain debt-to-equity ratio or interest coverage ratio) protect bondholders by ensuring the company stays financially stable.

==== 1. Affirmative (Positive) Covenants: - Things the company must do. - Example: maintain proper accounting records, carry insurance, pay taxes, provide financial statements. ====
# Negative Covenants: - Things the company is forbidden from doing. - Example: can’t pay excessive dividends, can’t sell major assets, can’t merge without approval, can’t issue too much additional debt.

==== Protective covenants protect bondholders. ====
They stop the company from doing things that would make it harder to repay the bond, like taking on too much debt, giving away cash to shareholders, or selling off assets.

Would you like me to also show how protective covenants are similar to “loan covenants” in bank lending (since banks use almost the same concept)?