Association for Financial Professionals (AFP) Practice Exam

Which of the following is commonly NOT included in bond indenture covenants?

1. The schedule for interest payments

2. Reporting requirements

3. The use of junior debt instruments

4. Prepayment terms

The correct answer is: The schedule for interest payments

The correct choice is the schedule for interest payments. In a bond indenture, the covenants primarily focus on the obligations and restrictions placed on the issuer to protect bondholders' interests. These covenants generally include management's responsibilities related to financial reporting, limitations on additional borrowing (such as the use of junior debt instruments), and conditions surrounding prepayment terms. The schedule for interest payments, however, is typically outlined as part of the bond's basic terms, which are fundamental aspects of the bond contract itself. While the timing of interest payments is crucial for bondholders, it is not structured as a covenant in the same way that operational or financial covenants are. Instead, it directly pertains to the terms of the bond issue. Other options mentioned, such as reporting requirements, the use of junior debt instruments, and prepayment terms, are distinctly categorized as covenants. They serve to manage the financial practices of the issuer and ensure that bondholders receive timely and transparent information regarding the company's financial status, as well as rules concerning financial leverage and the conditions under which the bond may be prepaid.