What does a rate covenant ensure in relation to debt service?

A rate covenant is a component of a bond agreement that addresses the management of rates charged to customers of a utility or similar operation. The essence of the covenant is to ensure that rates are set at a level sufficient to cover the operating expenses and debt service obligations of the entity. This means that after accounting for operating expenses, the net revenues must be adequate to meet the debt service requirements, which include principal and interest payments on the outstanding debt.

By committing to set these rates, the entity demonstrates its responsibility to maintain financial health and stability, assuring bondholders that there will be sufficient cash flow to honor debt obligations. This is crucial in maintaining investor confidence and ensuring ongoing access to capital markets for future borrowing needs. The other options do not accurately reflect the primary intent of a rate covenant, which focuses specifically on ensuring adequate revenues for covering debt service obligations.