What is a Bond Indenture?
Definition: Bond Indenture refers to an agreement associated with bond issuance. Likewise, it is a legal document between a bondholder and the bond issuer. The contract details and records the obligations of the person or firm issuing the bond as well as the benefits owed to the bondholder.
The capital markets are synonymous with binding agreements between companies and shareholders as well as owners. The legal and binding contracts detail the rights and responsibilities of each party involved in the agreement. Likewise, a bond indenture is a widespread binding agreement in the financial markets.
Bonds being fixed income securities promise to pay bondholders a specific interest rate as well as the principal amount upon maturity. Bond indenture, in this case, details all the terms of bonds right from issue size to coupon rate as well as steps taken in case the bond issuer fails to make payments.
A bond indenture also details the rights of ownership as well as the rights of a bondholder to receive payments in the form of interest until a bond matures.
Bond Indenture Terms
A bond indenture comes with several terms, key among them being a explanation of the bond, as well as the issuer restrictions. Likewise, it also details the course of action should the issuer fail to make timely payments. Some of the clauses included in a bond indenture include:
- Purpose: Details why a bond issuer is issuing a bond as well as its use
- Interest rate: A bond indenture must detail the interest rate on the face of the bond
- Interest Calculation: details the interest rate formula used to compute the interest
- Payment Dates: Details the dates when the bond issuer will issue payments
- Maturity Date: Indicates when the face value of the bond will be repaid
- Call Features: Details instances in which Bond issuer can buy back the bond before the bond maturity date
- Conversions Features: Details situation in which bond can be converted into common stock
- Non Payment Actions: Highlights actions in case bond issuer fails to make payments such as increasing interest rate or accelerating the maturity date
Bond Indenture Example: Guide To Bonds Legal Binding Agreement
Consider Company X wants to raise $100 million to enhance its production capacity. The terms of the bond included in the bond indenture may consist of the following conditions:
- An interest or coupon rate of 5% per year
- Interest payments made after every 6 months
- Each bond must have a face value of $1,000
- Principal to be paid at the end of 10 years (Maturity date)
How Bond Indenture Works
The legal binding agreement, which is bond indenture, is created before the issuance of a bond. State and federal governments, among other relevant authorities, must approve the binding agreement before the issuance of a bond.
Similarly, bond indenture is not issued to individual bondholders or people buying bonds. Instead, the agreements are issued to trustee or third party that represents bondholders as it is impractical to enter into a contract with each bondholder. The trustee can be a bank or any other financial institution tasked with the issuance of a bond.
The trustee ensures the issuer complies with all the obligations detailed in the bond indenture. Likewise, the trustee is obligated to take action on behalf of the bondholder. The trustee must also maintain or hold all the required documentation and records on behalf of bondholders. Likewise, the trustee is tasked with invoicing the issuer for interest payments as well as principal repayments as well as holding payments in transit.
Being a legal binding agreement, it is the responsibility of the trustee to lodge legal proceedings on behalf of the bondholders in case the issuer fails to meet some obligations. Likewise, bondholders can raise complaints with the trustee in a bid to push for a legal action in case their rights are violated.