Legal Definitions - asset-coverage test

An asset-coverage test is a restriction in a bond-indenture that allows a company to borrow more money only if the ratio of its assets to debt does not fall below a certain minimum. This test is used to ensure that a company has enough assets to cover its debts and can continue to pay its creditors.

Let's say 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 requires a minimum asset-coverage ratio of 1.5:1, the company would be allowed to borrow more money as long as its assets remain above $7.5 million (1.5 times its long-term debt).

Another example would be a company that has $20 million in assets and $10 million in long-term debt. The asset-coverage ratio would be 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 allowed to borrow more money until it increases its assets or reduces its debt.

These examples illustrate how the asset-coverage test works. It ensures that a company has enough assets to cover its debts and can continue to pay its creditors. If a company's asset-coverage ratio falls below the minimum required by the bond-indenture, it may be a sign that the company is in financial trouble and may not be able to meet its obligations.