What is a debt covenant?

A debt covenant refers to a clause in a loan agreement that establishes specific conditions or restrictions that the borrower must adhere to during the loan's term. These covenants are intended to protect the lender's interests by ensuring that the borrower maintains a certain level of financial health and operational discipline.

For instance, covenants may require the borrower to maintain minimum financial ratios, restrict additional debt, or mandate regular financial reporting. By doing so, lenders can mitigate risks associated with the borrower’s potential default or financial distress, as these covenants help ensure that the borrower remains financially stable and capable of repaying the loan.

The other options do not accurately capture the essence of what a debt covenant is. Marketing guidelines, agreements for purchasing assets, or penalties for late payments do not encompass the specific regulatory and supervisory nature of a debt covenant, which is fundamentally about maintaining loan conditions.