What restrictions are typically included in an indenture of bonds in order to protect the bondholder?

Question

What will be an ideal response?

Answer 1

The restrictive provisions included in the indenture of bonds attempt to protect the bondholders' financial position
relative to that of other outstanding securities. Common provisions involve 1. prohibiting the sale of the firm's
accounts receivable, 2. limiting common stock dividends, 3 . restricting the purchase or sale of the firm's fixed assets,
and 4. setting limits on additional borrowing by the firm.
Not allowing the sale of accounts receivable is specified because such sales would benefit the firm's short-run liquidity
position at the expense of its future liquidity position. Common stock dividends may not be allowed if the firm's
liquidity falls below a specified level, or the maximum dividend payout might be limited to some fraction, say, 50 or 60
percent of earnings. Fixed-asset restrictions generally require permission before they can be liquidated or used as
collateral on new loans. Constraints on additional borrowing usually involve limiting the amount and type of
additional long-term debt that can be issued. All these restrictions have one thing in common: They attempt to prohibit
actions that would improve the status of other securities at the expense of bonds and to protect the status of bonds
from being weakened by any managerial action.