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Definition of Covenants

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Covenants

Promise usually made in a contract whereby a party to the contract promises to do or not to do specified things.


Covenants

Provisions in a bond indenture or preferred stock agreement that require the bond or preferred
stock issuer to take certain specified actions (affirmative covenants) or to refrain from taking certain specified
actions (negative covenants).



Related Terms:

Restrictive covenants

Provisions that place constraints on the operations of borrowers, such as restrictions on
working capital, fixed assets, future borrowing, and payment of dividend.


Loan Covenants

Express stipulations included in loan agreements that are designed to monitor
corporate performance and restrict corporate acts, affording added protection to the lender.


Negative Loan Covenants

Loan covenants designed to limit a corporate borrower's behavior
in favor of the lender.


Positive Loan Covenants

Loan covenants expressing minimum and maximum financial measures
that must be met by a borrower.


Financial Covenants

A promise made related to financial conditions or events. Often a promise not to allow certain balance sheet items or ratios to fall below an agreed level. Usually found in loan documents, as a protection mechanism.


Conflict between bondholders and stockholders

These two groups may have interests in a corporation that
conflict. Sources of conflict include dividends, distortion of investment, and underinvestment. Protective
covenants work to resolve these conflicts.


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Financial Covenant

A feature of a debt or credit agreement that is designed to protect the lender or creditor. It is common to characterize covenants as either positive or negative covenants.
A positive covenant might require that the debtor maintain a minimum amount of working capital.
A negative covenant might limit dividend payments that may be made.


Gordon model

present value of a perpetuity with growth.
The end-ofyear Gordon model formula is: 1/(r - g)
and the midyear formula is: SQRT(1 + r)/(r - g).


Abandonment option

The option of terminating an investment earlier than originally planned.


Accrual bond

A bond on which interest accrues, but is not paid to the investor during the time of accrual.
The amount of accrued interest is added to the remaining principal of the bond and is paid at maturity.


Acquisition of assets

A merger or consolidation in which an acquirer purchases the selling firm's assets.


Acquisition of stock

A merger or consolidation in which an acquirer purchases the acquiree's stock.


Act of state doctrine

This doctrine says that a nation is sovereign within its own borders and its domestic
actions may not be questioned in the courts of another nation.


Adjustable rate preferred stock (ARPS)

Publicly traded issues that may be collateralized by mortgages and MBSs.


Affirmative covenant

A bond covenant that specifies certain actions the firm must take.


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American Stock Exchange (AMEX)

The second-largest stock exchange in the United States. It trades
mostly in small-to medium-sized companies.


Assets

A firm's productive resources.


Assets requirements

A common element of a financial plan that describes projected capital spending and the
proposed uses of net working capital.


Auction rate preferred stock (ARPS)

Floating rate preferred stock, the dividend on which is adjusted every
seven weeks through a Dutch auction.


Average cost of capital

A firm's required payout to the bondholders and to the stockholders expressed as a
percentage of capital contributed to the firm. Average cost of capital is computed by dividing the total
required cost of capital by the total amount of contributed capital.


Balance of payments

A statistical compilation formulated by a sovereign nation of all economic transactions
between residents of that nation and residents of all other nations during a stipulated period of time, usually a
calendar year.


Bearer bond

bonds that are not registered on the books of the issuer. such bonds are held in physical form by
the owner, who receives interest payments by physically detaching coupons from the bond certificate and
delivering them to the paying agent.


Beta equation (Stocks)

The beta of a stock is determined as follows:
[(n) (sum of (xy)) ]-[(sum of x) (sum of y)]
[(n) (sum of (xx)) ]-[(sum of x) (sum of x)]
where: n = # of observations (24-60 months)
x = rate of return for the S&P 500 Index
y = rate of return for the stock


Bond

bonds are debt and are issued for a period of more than one year. The U.S. government, local
governments, water districts, companies and many other types of institutions sell bonds. When an investor
buys bonds, he or she is lending money. The seller of the bond agrees to repay the principal amount of the
loan at a specified time. Interest-bearing bonds pay interest periodically.


Bond agreement

A contract for privately placed debt.


Bond covenant

A contractual provision in a bond indenture. A positive covenant requires certain actions, and
a negative covenant limits certain actions.


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Bond equivalent yield

bond yield calculated on an annual percentage rate method. Differs from annual
effective yield.


Bond indenture

The contract that sets forth the Promises of a corporate bond issuer and the rights of
investors.


Bond indexing

Designing a portfolio so that its performance will match the performance of some bond index.


Bond points

A conventional unit of measure for bond prices set at $10 and equivalent to 1% of the $100 face
value of the bond. A price of 80 means that the bond is selling at 80% of its face, or par value.


Bond value

With respect to convertible bonds, the value the security would have if it were not convertible
apart from the conversion option.


Bond-equivalent basis

The method used for computing the bond-equivalent yield.


Bond-equivalent yield

The annualized yield to maturity computed by doubling the semiannual yield.


BONDPAR

A system that monitors and evaluates the performance of a fixed-income portfolio , as well as the
individual securities held in the portfolio. bondPAR decomposes the return into those elements beyond the
manager's control--such as the interest rate environment and client-imposed duration policy constraints--and
those that the management process contributes to, such as interest rate management, sector/quality allocations,
and individual bond selection.


Brady bonds

bonds issued by emerging countries under a debt reduction plan.


Break-even lease payment

The lease payment at which a party to a prospective lease is indifferent between
entering and not entering into the lease arrangement.


Break-even payment rate

The prepayment rate of a MBS coupon that will produce the same CFY as that of
a predetermined benchmark MBS coupon. Used to identify for coupons higher than the benchmark coupon
the prepayment rate that will produce the same CFY as that of the benchmark coupon; and for coupons lower
than the benchmark coupon the lowest prepayment rate that will do so.


Bretton Woods Agreement

An agreement signed by the original United Nations members in 1944 that
established the International Monetary Fund (IMF) and the post-World War II international monetary system
of fixed exchange rates.


Builder buydown loan

A mortgage loan on newly developed property that the builder subsidizes during the
early years of the development. The builder uses cash to buy down the mortgage rate to a lower level than the
prevailing market loan rate for some period of time. The typical buydown is 3% of the interest-rate amount
for the first year, 2% for the second year, and 1% for the third year (also referred to as a 3-2-1 buydown).


Bull-bear bond

bond whose principal repayment is linked to the price of another security. The bonds are
issued in two tranches: in the first tranche repayment increases with the price of the other security, and in the
second tranche repayment decreases with the price of the other security.


Bulldog bond

Foreign bond issue made in London.


Bulldog market

The foreign market in the United Kingdom.


Bullet contract

A guaranteed investment contract purchased with a single (one-shot) premium. Related:
Window contract.


Buydowns

Mortgages in which monthly payments consist of principal and interest, with portions of these
payments during the early period of the loan being provided by a third party to reduce the borrower's monthly
payments.


Capital

Money invested in a firm.


Capital account

Net result of public and private international investment and lending activities.


Capital allocation

decision Allocation of invested funds between risk-free assets versus the risky portfolio.


Capital asset pricing model (CAPM)

An economic theory that describes the relationship between risk and
expected return, and serves as a model for the pricing of risky securities. The CAPM asserts that the only risk
that is priced by rational investors is systematic risk, because that risk cannot be eliminated by diversification.
The CAPM says that the expected return of a security or a portfolio is equal to the rate on a risk-free security
plus a risk premium.


Capital budget

A firm's set of planned capital expenditures.


Capital budgeting

The process of choosing the firm's long-term capital assets.


Capital expenditures

Amount used during a particular period to acquire or improve long-term assets such as
property, plant or equipment.


Capital flight

The transfer of capital abroad in response to fears of political risk.


Capital gain

When a stock is sold for a profit, it's the difference between the net sales price of securities and
their net cost, or original basis. If a stock is sold below cost, the difference is a capital loss.


Capital gains yield

The price change portion of a stock's return.


Capital lease

A lease obligation that has to be capitalized on the balance sheet.


Capital loss

The difference between the net cost of a security and the net sale price, if that security is sold at a loss.


Capital market

The market for trading long-term debt instruments (those that mature in more than one year).


Capital market efficiency

Reflects the relative amount of wealth wasted in making transactions. An efficient
capital market allows the transfer of assets with little wealth loss. See: efficient market hypothesis.


Capital market imperfections view

The view that issuing debt is generally valuable but that the firm's
optimal choice of capital structure is a dynamic process that involves the other views of capital structure (net
corporate/personal tax, agency cost, bankruptcy cost, and pecking order), which result from considerations of
asymmetric information, asymmetric taxes, and transaction costs.


Capital market line (CML)

The line defined by every combination of the risk-free asset and the market portfolio.


Capital rationing

Placing one or more limits on the amount of new investment undertaken by a firm, either
by using a higher cost of capital, or by setting a maximum on parts of, and/or the entirety of, the capital
budget.


Capital structure

The makeup of the liabilities and stockholders' equity side of the balance sheet, especially
the ratio of debt to equity and the mixture of short and long maturities.


Capital surplus

Amounts of directly contributed equity capital in excess of the par value.


Capitalization

The debt and/or equity mix that fund a firm's assets.


Capitalization method

A method of constructing a replicating portfolio in which the manager purchases a
number of the largest-capitalized names in the index stock in proportion to their capitalization.


Capitalization ratios

Also called financial leverage ratios, these ratios compare debt to total capitalization
and thus reflect the extent to which a corporation is trading on its equity. capitalization ratios can be
interpreted only in the context of the stability of industry and company earnings and cash flow.


Capitalization table

A table showing the capitalization of a firm, which typically includes the amount of
capital obtained from each source - long-term debt and common equity - and the respective capitalization
ratios.


Capitalized

Recorded in asset accounts and then depreciated or amortized, as is appropriate for expenditures
for items with useful lives greater than one year.


Capitalized interest

Interest that is not immediately expensed, but rather is considered as an asset and is then
amortized through the income statement over time.


Cash deficiency agreement

An agreement to invest cash in a project to the extent required to cover any cash
deficiency the project may experience.


Cash dividend

A dividend paid in cash to a company's shareholders. The amount is normally based on
profitability and is taxable as income. A cash distribution may include capital gains and return of capital in
addition to the dividend.


Cash flow from operations

A firm's net cash inflow resulting directly from its regular operations
(disregarding extraordinary items such as the sale of fixed assets or transaction costs associated with issuing
securities), calculated as the sum of net income plus non-cash expenses that were deducted in calculating net
income.


Cash settlement contracts

futures contracts, such as stock index futures, that settle for cash, not involving
the delivery of the underlying.


Certainty equivalent

An amount that would be accepted in lieu of a chance at a possible higher, but
uncertain, amount.


Clearing House Automated Payments System (CHAPS)

A computerized clearing system for sterling funds
that began operations in 1984. It includes 14 member banks, nearly 450 participating banks, and is one of the
clearing companies within the structure of the Association for payment Clearing Services (APACS).


Clearing House Interbank Payments System (CHIPS)

An international wire transfer system for high-value
payments operated by a group of major banks.


Collateral trust bonds

A bond in which the issuer (often a holding company) grants investors a lien on
stocks, notes, bonds, or other financial asset as security. Compare mortgage bond.


Collection fractions

The percentage of a given month's sales collected during the month of sale and each
month following the month of sale.


Collective wisdom

The combination of all of the individual opinions about a stock's or security's value.


Common stock

These are securities that represent equity ownership in a company. Common shares let an
investor vote on such matters as the election of directors. They also give the holder a share in a company's
profits via dividend payments or the capital appreciation of the security.


Common stock/other equity

Value of outstanding common shares at par, plus accumulated retained
earnings. Also called shareholders' equity.


Common stock equivalent

A convertible security that is traded like an equity issue because the optioned
common stock is trading high.


Common stock market

The market for trading equities, not including preferred stock.


Common stock ratios

Ratios that are designed to measure the relative claims of stockholders to earnings
(cash flow per share), and equity (book value per share) of a firm.


Complete capital market

A market in which there is a distinct marketable security for each and every
possible outcome.


Completion bonding

Insurance that a construction contract will be successfully completed.


Completion undertaking

An undertaking either (1) to complete a project such that it meets certain specified
performance criteria on or before a certain specified date or (2) to repay project debt if the completion test
cannot be met.


Concession agreement

An understanding between a company and the host government that specifies the
rules under which the company can operate locally.


Conditional sales contracts

Similar to equipment trust certificates except that the lender is either the
equipment manufacturer or a bank or finance company to whom the manufacturer has sold the conditional
sales contract.


Conflict between bondholders and stockholders

These two groups may have interests in a corporation that
conflict. Sources of conflict include dividends, distortion of investment, and underinvestment. Protective
covenants work to resolve these conflicts.


Continuous random variable

A random value that can take any fractional value within specified ranges, as
contrasted with a discrete variable.


Contract

A term of reference describing a unit of trading for a financial or commodity future. Also, the actual
bilateral agreement between the buyer and seller of a transaction as defined by an exchange.


Contract month

The month in which futures contracts may be satisfied by making or accepting a delivery.
Also called value managers, those who assemble portfolios with relatively lower betas, lower price-book and
P/E ratios and higher dividend yields, seeing value where others do not.


Convertible bonds

bonds that can be converted into common stock at the option of the holder.


Convertible eurobond

A eurobond that can be converted into another asset, often through exercise of
attached warrants.


Convertible exchangeable preferred stock

Convertible preferred stock that may be exchanged, at the
issuer's option, into convertible bonds that have the same conversion features as the convertible preferred
stock.


Convertible preferred stock

preferred stock that can be converted into common stock at the option of the holder.


Corporate bonds

Debt obligations issued by corporations.


Cost of capital

The required return for a capital budgeting project.


Cost of limited partner capital

The discount rate that equates the after-tax inflows with outflows for capital
raised from limited partners.


Counterparty Party

on the other side of a trade or transaction.


Counterparty risk

The risk that the other party to an agreement will default. In an options contract, the risk
to the option buyer that the option writer will not buy or sell the underlying as agreed.
Country economic risk Developments in a national economy that can affect the outcome of an international
financial transaction.


Coupon payments

A bond's interest payments.


Cramdown

The ability of the bankruptcy court to confirm a plan of reorganization over the objections of
some classes of creditors.


Cum dividend

With dividend.


Cumulative dividend feature

A requirement that any missed preferred or preference stock dividends be paid
in full before any common dividend payment is made.


 

 

 

 

 

 

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