Negative/Positive Covenant

CFA Level I
#1

Not sure if I am allowed to post a Schweser question but it is part of the question for a day. I am having trouble understanding this question:

Requiring a bond issuer to act as the acquiring company in a business combination or prohibiting the merger would MOST LIKELY be considered an example of a(n):

The answer is negative covenant. The question makes it sound like if the bond issuer DOES NOT act as an acquiring company, the merger would be prohibited.

Is it because there is a restriction which is: in order to engage in M&A, the company needs to be the acquiring company. And a positive covenant would require the company to do something (regardless of any other conditions)?

On first thought, I thought it was positive just because the company is being forced to do something. But because they are not required to do it (if they don’t plan to engage in M&A), it is a negative covenant.

#2

Positive covenants are usually administrative in nature. This is negative because it, basically, prevents adverse consequences on capital structure and therefore debt holders.

#3

I have the same doubt,

let’s put another 2 scenarios,1- company x is required to maintain an Net debt/ EBITDA ratio bellow 4x, or it will be considered in default

2- company k can only distribute dividends in a maximum of 35% of net income if Fixed charges coverage is above 2,5x

These 2 examples are negative or affirmative covenants?

Thanks in advance for reading my doubt

#4

Affirmative covenants are the “Thou Shalt” items in the indenture.

The first is an affirmative covenant - a requirement that the issuer/borrower DO something.

A Negative covenant is a “Thou Shalt Not” item in the indenture

The second is a negative covenant - it says that the issuer/borrow is constrained from doing something - i.e. they SHALL NOT distribute dividends of > 35% of net income if FCC is less than 2.5x

#5

Thank you busprof

#6

In the original question, (Requiring a bond issuer to act as the acquiring company in a business combination or prohibiting the merger would MOST LIKELY be considered an example of a(n))

You could rephrase it as "the issuer shall not enter into a business combination where they are NOT the acquiring company, or “The issuer shall not enter into a merger”

So, negative covenants