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Investor Insigh1 - more recent years however when there was...

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Investor Insight Geoffrey Hammond/iStockphoto. In many corporate loans and bond issuances the lending agreement specifies debt covenants . These covenants typically are specific financial measures, such as minimum levels of retained earnings, cash flows, times interest earned ratios, or other measures that a company must maintain during the life of the loan. If the company violates a covenant, it is considered to have violated the loan agreement; the creditors can demand immediate repayment, or they can renegotiate the loan's terms. Covenants protect lenders because they enable lenders to step in and try to get their money back before the borrower gets too deep into trouble. During the 1990s most traditional loans specified between three to six covenants or “triggers.” In
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Unformatted text preview: more recent years, however, when there was lots of cash available, lenders began reducing or completely eliminating covenants from loan agreements in order to be more competitive with other lenders. In a weaker economy these lenders will be more likely to lose big money when companies default. How can financial ratios such as those covered in this chapter provide protection for creditors? Answer: Financial ratios such as the current ratio, debt to total assets ratio, and the times interest earned ratio provide indications of a company's liquidity and solvency. By specifying minimum levels of liquidity and solvency, as measured by these ratios, a creditor creates triggers that enable it to step in before a company's financial situation becomes too dire....
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