Question

5

What is the purpose of a covenant analysis?

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To calculate the financial and leverage ratios commonly used by commercial banks as covenants in assessing a company’s credit rating

To evaluate the risk rating of a company by calculating the weighted average of various key ratios

To forecast the monthly working capital funding gap and analyze the need for operating line

To construct the debt schedules for various types of debt and calculate the cash flows

Answer 1

Ans. Option A is correct.

To calculate the financial and leverage ratios commonly used by commercial banks as covenants in assessing a company’s credit rating

Reason: The purpose of a covenant analysis is to calculate the financial and leverage ratios for determining the credit rating of company. It helps commercial banks to determine various limits for borrower beyond which loan covenants will be violated. Like one of covenant could be that borrower cannot borrow further without permission of commercial bank. If borrower breaks covenants, lender could demand repayment of loan before maturity of loan. So, covenant analysis involves calculation of the financial and leverage ratios for assessing a company’s credit rating.