What does the debt service coverage ratio measure and why is it important for bond ratings?

• A. It measures revenue growth year over year.
• B. It measures annual debt service against available revenues; higher coverage improves credit ratings and debt issuance viability.
• C. It measures capital expenditure adequacy.
• D. It measures student attendance.

Answer: (B)

The main idea tested is how a government entity’s ability to meet debt payments from its revenues is evaluated. The debt service coverage ratio compares the funds available to service debt with the annual debt service due. Put simply, DSCR = available revenues divided by debt service. A higher ratio means there’s more cushion if revenue fluctuates, signaling lower risk to lenders and investors.

This is why it matters for bond ratings: rating agencies look at whether the entity can reliably cover debt payments from its ongoing revenues. A stronger DSCR implies safer debt obligations and often leads to a higher credit rating and easier, cheaper debt issuance. For example, a DSCR above 1 shows the entity can cover payments; the larger the ratio, the greater the perceived safety. If the ratio falls close to or below 1, the ability to meet debt service is uncertain, which can lead to a lower rating and higher borrowing costs.