Covenant

AAA

DEFINITION of 'Covenant'

A promise in an indenture, or any other formal debt agreement, that certain activities will or will not be carried out. Covenants in finance most often relate to terms in a financial contracting, such as loan documation stating the limits at which the borrower can further lend or other such stipulations. Covenants are put in place by lenders to protect themselves from borrowers defaulting on their obligations due to financial actions detrimental to themselves or the business.

INVESTOPEDIA EXPLAINS 'Covenant'

Covenants are most often represented in terms of financial ratios which must be maintained for businesses which lend, such as a maximum debt-to-asset ratio or other such ratios. Covenants can cover everything from minimum dividend payments to levels that must be maintained in working capital to key employees remaining with the firm. Once a covenant is broken, the lender will typically have the right to call back the obligation from the borrower.

VIDEO

Loading the player...
RELATED TERMS
  1. Indenture

    A legal and binding contract between a bond issuer and the bondholders.
  2. Security Agreement

    A document that provides a lender a security interest in a specified ...
  3. Negative Covenant

    A bond covenant preventing certain activities, unless agreed ...
  4. IOU

    An informal document that acknowledges a debt owed. IOU is an ...
  5. Liquidity

    1. The degree to which an asset or security can be bought or ...
  6. Project Completion Restriction

    A type of clause, seen most often in municipal bond indentures, ...
RELATED FAQS
  1. What are the risks of investing in a company that has a high net debt?

    High net debt increases the risk borne by common shareholders and is one of the first items on the balance sheet to be analyzed. ... Read Full Answer >>
  2. How is a leveraged buyout different from a buyout?

    In finance, a buyout refers to a purchase of voting stock of a target firm by an acquiring company, where the acquirer gains ... Read Full Answer >>
  3. What are some examples of Cash Flow from Financing (CFF)?

    The cash flow statement is a financial statement showing the net change in cash for a company in a given period. Entries ... Read Full Answer >>
  4. Over what duration should I be evaluating a company's total debt to total assets ...

    Total debt to total assets measures the amount of leverage a company used to acquire assets. It is used as a measure of its ... Read Full Answer >>
  5. Why might a bond agreement limit the amount of assets that the firm can lease?

    Bond covenants can limit the amount of leases a company can have because leasing contracts are a form of debt. Taking on ... Read Full Answer >>
  6. Why do companies issue debt and bonds? Can't they just borrow from the bank?

    Companies issue bonds to finance operations. Most companies can borrow from banks, but view direct borrowing from a bank ... Read Full Answer >>
Related Articles
  1. Economics

    Understanding Covenants

    A covenant is a term placed in a loan that requires the borrower to either maintain or refrain from certain business activities.
  2. Markets

    Material Adverse Effect A Warning Sign For Stocks

    Learn what this phrase means and how to spot it in a company's financial statements.
  3. Options & Futures

    Understanding Financial Liquidity

    Understanding how this measure works in the market can help keep your finances afloat.
  4. Economics

    How Does a Lien Work?

    A lien gives a creditor the legal right to seize and sell property, then use the proceeds to pay off a borrower’s debt.
  5. Credit & Loans

    How To Increase Your Appeal To Prospective Lenders

    Making a business eligible for loans/credit cards at the best possible rates requires crafting an excellent credit profile through the smart use of credit.
  6. Economics

    What is Earnest Money?

    An earnest money deposit shows the seller that a buyer is serious about purchasing a property.
  7. Economics

    Venezuela Teeters On Edge As Oil Revenues Shrink

    Low oil prices have drastically revised the economic status quo -- dealing a destabilizing blow to oil-exporters like Venezuela due to falling oil revenue.
  8. Economics

    Does A Junk Rating Reflect Russia's Fundamentals?

    Moody’s, like other credit rating agencies, has downgraded Russia’s sovereign debt rating to non-investment grade, but does this reflect Russia's economy?
  9. Stock Analysis

    Find The Right Discount Rate Amid Post-2007 Risks

    OIS discounting has become part of standard valuation techniques, in a market in which there is more uncertainty and less proxies for the risk-free rate.
  10. Trading Strategies

    Eyeing a Loan? Consider Skipping the Banks

    Peer-to-peer lending platforms, such as Lending Tree, Lending Club and Prosper, offer borrowers newfound leverage. Here's a look.

You May Also Like

Hot Definitions
  1. Multicurrency Note Facility

    A credit facility that finances short- to medium-term Euro notes. Multicurrency note facilities are denominated in many currencies. ...
  2. National Currency

    The currency or legal tender issued by a nation's central bank or monetary authority. The national currency of a nation is ...
  3. Treasury Yield

    The return on investment, expressed as a percentage, on the debt obligations of the U.S. government. Treasuries are considered ...
  4. Bund

    A bond issued by Germany's federal government, or the German word for "bond." Bunds are the German equivalent of U.S. Treasury ...
  5. European Central Bank - ECB

    The central bank responsible for the monetary system of the European Union (EU) and the euro currency. The bank was formed ...
  6. Quantitative Easing

    An unconventional monetary policy in which a central bank purchases private sector financial assets in order to lower interest ...
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!