The primary purpose of bond covenants is to:

• A. Reduce the interest rate paid to bondholders
• B. Protect the interests of bondholders by restricting certain actions of the issuer
• C. Guarantee the payment of dividends to shareholders
• D. Increase the market value of the bonds

Answer: (B)

Verified step by step guidance

1. Understand the concept of bond covenants: Bond covenants are legally binding agreements included in the bond contract to protect the interests of bondholders. They impose restrictions or obligations on the issuer to ensure the issuer's financial stability and ability to repay the bondholders.
2. Analyze the purpose of bond covenants: The primary purpose is to safeguard bondholders by limiting the issuer's actions that could jeopardize the repayment of the bonds. For example, covenants may restrict excessive borrowing or require the issuer to maintain certain financial ratios.
3. Evaluate the options provided in the problem: Review each option and determine whether it aligns with the purpose of bond covenants. For instance, reducing the interest rate paid to bondholders is not a direct purpose of covenants, nor is guaranteeing dividends to shareholders.
4. Focus on the correct answer: The correct answer is 'Protect the interests of bondholders by restricting certain actions of the issuer.' This aligns with the primary purpose of bond covenants, as they are designed to ensure bondholders are repaid and their investment is safeguarded.
5. Conclude the analysis: Bond covenants are essential for maintaining trust between bondholders and issuers, ensuring that issuers act responsibly and prioritize repayment obligations over risky financial decisions.