Explain the difference between maintenance and incurrence covenants, give one concrete example of each, and state which instrument each is typically found in.

What interviewers are actually testing

This lesson shows up in markets questions ("Where are high-yield spreads and what does that tell you?"), in LBO discussions ("How would you finance this buyout?"), and in fit questions for leveraged finance and restructuring groups. The interviewer is testing three things.

First, do you know the vocabulary cold? Spread vs yield vs coupon; IG vs HY boundary (BBB−/BB+); loans vs bonds; maintenance vs incurrence covenants; cov-lite. Fumbling basic definitions here signals you have never read a deal memo or a Debtwire headline.

Second, can you connect credit conditions to deal activity? A strong candidate volunteers the transmission chain: spreads widen → all-in financing cost rises → maximum leverage falls → LBO purchase prices fall or equity checks grow → deal volume slows. Saying "HY spreads are around X bps right now, which is tight/wide versus the ~400 bps long-run average, so financing markets are open/shut" is a huge fluency signal. Know the current number within ~50 bps before any superday.

Third, do you understand the instruments as an investor would? Why does a TLB price inside the same issuer's senior notes? (Security and seniority → higher recovery → lower spread.) Why do sponsors like cov-lite? (No quarterly test means no technical default during a rough patch; lenders lose their early trigger.) Why do HY bonds have call protection? (Investors need protection on fixed coupons; issuers pay for the option to refinance.)

Strong candidates use precise units (bps, not "percent"), cite the direction of price/spread moves correctly (wider spread = lower price), and can sketch a realistic LBO structure unprompted: "revolver undrawn, TLB at SOFR+350 for 4x, senior notes at 8.5% for another 1.5x, rest equity." That single sentence tells the interviewer you can sit in a LevFin staffing meeting tomorrow.

Common traps

Trap 1: Confusing coupon, yield, and spread. The coupon is the fixed contractual cash payment; the yield is the market-implied return at the current price; the spread is yield minus the benchmark. A bond issued at par with an 8% coupon that now trades at 92 has a yield well above 8% and its spread has widened. The coupon never changed.

Say it out loud: "The coupon is fixed at issuance; yield and spread move with the price. If the bond trades below par, its yield exceeds the coupon, and the spread over Treasuries is the market's current price of its credit risk."

Trap 2: Getting the spread/price direction backwards. Candidates say "spreads widened, so bonds rallied." Wrong: wider spreads mean higher required yields, which means lower prices. Widening = bearish for credit.

Say it out loud: "Spread widening means investors demand more yield for the same cash flows, so prices fall: widening is credit weakness, tightening is credit strength."

Trap 3: Mixing up maintenance and incurrence covenants. The test is when compliance is checked: maintenance = tested every quarter no matter what; incurrence = tested only when the issuer acts (new debt, dividend, asset sale).

Say it out loud: "Maintenance covenants are tested quarterly regardless of any action: breach alone is a default. Incurrence covenants only bite when the company tries to do something, like raise debt or pay a dividend."

Trap 4: Saying cov-lite means 'no covenants.' Cov-lite loans still carry the full suite of incurrence-style negative covenants; what they lack is the quarterly maintenance test.

Say it out loud: "Cov-lite doesn't mean covenant-free: it means the term loan has no financial maintenance test, so lenders can't call a default just because leverage drifts up; the negative covenants on debt, liens, and dividends all still apply."

Trap 5: Treating loans and bonds as interchangeable. They differ on rate (floating vs fixed), security (secured vs typically unsecured), callability (loans prepayable near par; bonds have non-call periods), amortization, and investor base (CLOs vs bond funds).

Say it out loud: "The term loan is floating-rate, first-lien secured, and prepayable near par; the high-yield bond is fixed-rate, typically unsecured, non-call three, and a bullet. That's why the loan prices tighter and why rising rates hit loan-heavy structures immediately."

Trap 6: Misplacing the IG/HY boundary. It is BBB−/Baa3 (lowest IG) versus BB+/Ba1 (highest HY). Saying "BB is investment grade" is an instant credibility hit in a LevFin interview.

Say it out loud: "Investment grade runs down to BBB minus; BB plus and below is high yield. A downgrade across that line (a fallen angel) forces selling by IG-only investors and structurally raises the issuer's cost of capital."