RT Journal Article
SR Electronic
T1 Pricing Corporate Bonds with Rating-Based Covenants
JF The Journal of Fixed Income
FD Institutional Investor Journals
SP 57
OP 64
DO 10.3905/jfi.2003.319339
VO 12
IS 4
A1 Karan Bhanot
YR 2003
UL https://pm-research.com/content/12/4/57.abstract
AB A corporate bond indenture often includes covenants that allow bondholders to take specific actions (e.g., force prepayment or reorganization) if certain specific conditions are violated. A typical covenant is triggered by a downgrade in credit rating. This article provides a simple framework for the valuation of a corporate bond with a rating-based covenant. Basic assumptions that are consistent with empirical evidence are that a downgrade in credit rating is accompanied by more volatility in assets, and that corporate reorganization after a rating change results in a change in payments to equityholders and other securityholders. The model may be used to compare risky bonds with covenants and bonds without convenants.