Asset-Coverage Test is a regulation that stipulates a company can only obtain additional loans if they possess sufficient assets, such as buildings or equipment, to offset their debts. This test establishes a minimum ratio of assets to debt that the company must uphold in order to be eligible for further borrowing.
The asset-coverage test is a provision in a bond-indenture that permits a company to borrow additional funds only if the ratio of its assets to debt remains above a specified minimum. This test is implemented to guarantee that the company possesses sufficient assets to cover its debts and fulfil its obligations to creditors. For instance, if a company has $10 million in assets and $5 million in long-term debt, the asset-coverage ratio would be 2:1 ($10 million divided by $5 million). If the bond-indenture stipulates a minimum asset-coverage ratio of 1.5:1, the company would be eligible to borrow more funds as long as its assets remain above $7.5 million (1.5 times its long-term debt). Another scenario involves a company with $20 million in assets and $10 million in long-term debt, resulting in an asset-coverage ratio of 2:1 ($20 million divided by $10 million). If the bond-indenture requires a minimum asset-coverage ratio of 2:1, the company would not be permitted to borrow additional funds until it increases its assets or reduces its debt. These examples effectively demonstrate the functioning of the asset-coverage test, which ensures that a company possesses adequate assets to cover its debts and fulfil its obligations to creditors. If a company’s asset-coverage ratio falls below the minimum required by the bond-indenture, it may indicate financial distress and an inability to meet its obligations.
The Asset-Coverage Test is a financial test used to determine if a company has enough assets to cover its debts and obligations.
Companies that issue bonds or other debt securities are required to take the Asset-Coverage Test.
The purpose of the Asset-Coverage Test is to ensure that companies have enough assets to cover their debts and obligations, which helps protect investors.
The Asset-Coverage Test is calculated by dividing a company’s total assets by its total liabilities.
The minimum Asset-Coverage Test ratio required by law is 1.0, which means that a company’s total assets must be equal to or greater than its total liabilities.
If a company fails the Asset-Coverage Test, it may be in violation of securities laws and may be required to take corrective action or face penalties.
Yes, a company can take steps to improve its Asset-Coverage Test ratio by increasing its assets or reducing its liabilities.
Yes, certain types of debt securities, such as short-term commercial paper, may be exempt from the Asset-Coverage Test requirement.
The Asset-Coverage Test requirement is enforced by the Securities and Exchange Commission (SEC).
In addition to the Asset-Coverage Test, companies that issue debt securities may also be required to take other financial tests, such as the Interest Coverage Test and the Fixed Charge Coverage Test.
This site contains general legal information but does not constitute professional legal advice for your particular situation. Persuing this glossary does not create an attorney-client or legal adviser relationship. If you have specific questions, please consult a qualified attorney licensed in your jurisdiction.
This glossary post was last updated: 17th April 2024.
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