I got a question here relating to a practice q… i think they have something wrong here:
Debt covenants to protect bold holders are least likely to:
a) restrict issuance of new debt
b) require sinking fund redemptions
c) prohibit bond repurchases at premium to par
The answer they have listed here is C… I’ve gone with A:
-Why would a bond holder ask for a repurchase at premium to par? Wouldnt they be exposed to reinvestment risk? I eliminated B because of the whole ‘prepayment’ risk thing… it seems this question is at odds with what we were reading in the FI section of the course.
They are asking for least likely. Bondholders don’t want anyone stepping in front of them so A is likely. They like having some of their money paid pack before maturity so B is likely. They like making a profit on their capital when rates go down so C is not likely.
Also, the reinvestment risk is not an issue because you are receiving a premium over the amount of money you lent the company. For example, if you loaned them 100 dollars at 10 percent you will receive 10 dollars. If rates go to 5 percent and they pay you 200 dollars you will still receive 10 dollars per year in cash flow.