Canadian Securities Course (CSC) Level 1 Practice Exam

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What are protective provisions in a bond contract?

Ensure the issuer makes higher interest payments
Protect against weakening the security holder's position
Set a limit on the bond's face value
Require the issuer to pay off the bond immediately

The correct answer is: Protect against weakening the security holder's position

Protective provisions in a bond contract are designed specifically to safeguard the interests of bondholders, ensuring that their position is not compromised. These provisions may include a variety of clauses that restrict the issuer's ability to take certain actions that could undermine the value or security of the bond. For example, protective provisions can limit the issuer's ability to incur additional debt, sell significant assets, or change the nature of the business without bondholder consent. By including such provisions, bondholders are afforded greater security and assurance that the issuer will not engage in activities that might dilute their claims or negatively impact their investment. In contrast, the other options do not accurately describe protective provisions: they do not increase interest payments or cap the bond's face value. Additionally, they do not require immediate repayment of the bond, which could disrupt the issuer's financial planning. Therefore, the role of protective provisions is fundamental to maintaining a favorable risk-reward balance for bondholders throughout the life of the bond.