Final answer:
A debt covenant is a clause within a lending agreement that sets financial limits and conditions on the borrower, protecting the lender and potentially offering the borrower better lending terms.
Step-by-step explanation:
Understanding Debt Covenants
A debt covenant is a clause within a lending agreement that sets financial performance limits on the borrower. These covenants are designed to protect the lender by ensuring the borrower maintains a certain financial position and complies with specific terms. There are various types of debt covenants, but they commonly require the borrower to adhere to financial ratios for solvency or to avoid certain behaviors that would increase financial risk. By including these covenants in lending agreements, lenders have a measure of control over the risk they are taking on, while borrowers are often able to obtain more favorable lending terms as a result of committing to these conditions.