Question: Debt contracts may contain covenants such as maintaining a specified
Debt contracts may contain covenants, such as maintaining a specified level of working capital, not exceeding a specified debt– equity ratio, or maintaining an agreed times interest earned ratio. Explain how these covenants help to generate the lenders’ trust that is necessary if the firm is to borrow at reasonable cost. Do these covenants give lenders complete trust that their interest and principal will be paid? Explain.
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