Canadian Securities Course (CSC) Practice Exam

What is the purpose of a Negative Pledge Provision in a company's debenture issue?

1. a bond with an option allowing the bondholder to exchange the bond for a specified number of shares of common stock in the firm.

2. a protective provision providing that no subsequent mortgage bond issue may be secured by all or part of the company's assets.

3. sums of money set aside out of earnings each year to provide for the repayment of all or part of a debt issue at maturity.

4. a short-term commercial draft sold at a discount.

The correct answer is: a protective provision providing that no subsequent mortgage bond issue may be secured by all or part of the company's assets.

A Negative Pledge Provision is a protective measure that ensures the assets of a company cannot be used as collateral for any future bond issues. This option will limit the company's ability to secure additional debt against its assets, safeguarding existing bondholders' interests. A is incorrect because it describes a convertible bond, not a Negative Pledge Provision. B is the correct answer as it properly describes the purpose of a Negative Pledge Provision. C is incorrect because it describes a sinking fund provision, not a Negative Pledge Provision. D is incorrect because it describes a banker's acceptance, not a Negative Pledge Provision. While it is true that these provisions are commonly used in debenture issues, they do not serve the same function as a Negative Pledge Provision.