Question

Discuss the TWO (2) common tests in bond credit analysis.

Discuss the TWO (2) common tests in bond credit analysis.

Homework Answers

Answer #1

There must always be some limitations on the company’s ability to incur the debt because unrestricted borrowings will harm the bondholders of the company. So the bondholders require some type of fixed coverage ratio tests to limit the debts outstanding.

Two common tests in bond credit analysis are :

  1. Maintenance test : Maintenance test is concerned about the borrowers ratio of earnings which is available for the payment of interest or other fixed charges. Maintenance test requires this ratio to be at least a minimum figure on each reporting date taken into consideration. Such period can be quarterly or annually.
  2. Debt incurrence test : The debt incurrence test is used when the company wishes to go for some additional borrowing. For taking additional debt, the bondholders require the interest or fixed charge coverage ratio considered for the new debt to be a certain minimum level for the reporting period prior to the financing. These are less stringent than maintenance tests.
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