A bond is a debt instrument available to companies, municipalities, cities, and other organizations. These entities can gather funding by issuing this instrument.
In exchange, the holder receives a promise from the issuer to get repaid in the future. Usually, this promise depends on the bond’s maturity date. On top of that, holders may also receive a coupon payment, which occurs regularly.
Bonds carry a coupon rate that dictates the amount the holder receives. On top of that, the face value will also play a role in calculating that amount. This amount represents income for the holder, which they get at regular intervals.
The promise of this income makes bonds preferable for many holders. On the other hand, the issuer receives finance for a set period. However, they also incur expenses related to coupon payments.
A bond also represents a contract between two parties. This contract binds both parties to their duties and responsibilities. On top of that, it also makes their agreement legally enforceable.
Both parties usually agree to the contract through the issuance process. These bonds also mention the terms that apply to them. These terms come within the bond indenture.
What is a Bond Indenture?
The term indenture means a legal agreement, contract, or document. Usually, this contract includes all the terms and conditions associated with the relationship. This relationship is crucial in allowing both parties to understand their roles.
In the context of a bond, an indenture has a similar meaning. A bond indenture is a contract attached to a bond. This contract occurs between the issuer and the holder.
A bond indenture is a legal contract that binds two parties. As mentioned, these include the bond issuer and holder. In most of these transactions, a third party facilitates the exchange.
This party may consist of a guarantor, for example, a financial institution or bank. This party acts as a trustee for bond indentures and becomes an intermediary in the transaction.
Since bond indentures are legal contracts, a trustee may be crucial in arranging the transaction. However, some companies may also issue these products through a market. In most cases, it includes a bond market, where these transactions are prevalent.
The trustee also handles the bond indenture and ensures both parties intend to satisfy those terms. This indenture may include various features.
Another name used for the bond indenture is bond resolution. It represents a core legal document that binds the bond issuer and holder.
Similarly, it includes all the details related to the bond. These details dictate the relationship that exists between those parties.
This contract also records the obligations of the issuer owed to the holder. Usually, the issuer creates this document when issuing the bond.
Overall, a bond indenture is a document or contract attached to it. This contract includes details about several aspects of the bond.
The issuer creates the document that sets the relationship between them and the holder. Usually, the issuer must obtain the services of a trustee to mediate the contract.
In this relationship, the issuer issues the indenture to the trustee. The latter then controls the relationship with the bondholder.
What is included in a Bond Indenture?
A bond indenture is a legal contract between a bond issuer and a holder. This document includes various terms and clauses which relate to an issued bond. Usually, it consists of crucial components in dictating the relationship between both parties.
Some of these elements included in a bond indenture include the following.
Purpose
A bond indenture includes the purpose behind the issuance of the bond. Within this clause, the issuer describes the intended use of the money. On the other hand, it assures the investor of how their funds will get used.
Face value
Every bond includes a face value. As mentioned, this value plays a role in determining the coupon payments that the holder will receive. It also represents the amount the holder will receive once the bond reaches maturity.
The face value is also known as the par or nominal value. However, it is not similar to the market value of the bond.
Maturity
The bond maturity is the date at which the bond expires. In other words, it represents the time when the issuer repays the holder.
The bond’s maturity rate also plays a role in its market value and carrying value. It is one of the crucial areas of a bond indenture.
Coupon rate
The coupon rate represents a percentage that applies to its face value. Based on this rate, issuers calculate the coupon payments that the holders will receive. Coupon rates are crucial in bond indentures as they represent income for the holder.
Coupon calculation
The bond indenture also consists of the method for calculating the interest. Usually, bonds are fixed payment instruments and involve a straightforward process.
However, some bonds may also include floating rates or compound interest. For those bonds, mentioning the coupon calculation is crucial.
Payment dates
The bond indenture will also include the payment dates. These are the dates or times when the holder will receive their coupon payments. Usually, it depends on how often the issuer intends to pay the holders.
Call features
The bond indenture will also include the call features for callable bonds. On top of that, it will also mention the call protection period. This period represents the time during which the bond is irreplaceable or irredeemable.
Default actions
The bond indenture also includes the terms for defaults. These terms describe the possible actions necessary when the issuer fails to pay interest or the face value.
Usually, they may involve increasing the interest rate, penalties, and reduction in maturity period. The default clause protects the bondholders against any possible issues with issuers failing to repay.
Collateral
Collateral is the security offered in exchange for the issuance of a bond. The clauses related to this feature only apply to secured bonds. Usually, bonds may include different types of collaterals. On top of that, they may apply to specific bonds.
For example, they include collateral, trust, mortgage, covered, etc. The bond indenture also contains a clause on what happens to the collateral in case of a default.
Covenant
The bond indenture may also include a covenant. This clause protects the interest of the bond issuer and the holder. Through this clause, the holders may impose restrictions on how issuers use their funds. Similarly, the covenant covers issuers’ requirements during the bond period.
This clause may also restrict the issuer to particular activities. However, covenants are more common for issuers with lower creditworthiness.
What are the advantages and disadvantages of a Bond Indenture?
A bond indenture can have several advantages for both parties. Some of these include the following.
- It legally binds the bond issuer and holder during the bond issuance process.
- It includes conditions that apply to the relationship between the bond issuer and the holder.
- It clarifies the features of a bond. These include some of the components of the bond indenture mentioned above.
- It helps protect the investor’s rights through specific terms, such as covenants.
- It defines the roles and responsibilities of all stakeholders in the bond indenture.
On the other hand, bond indentures can also have some disadvantages. Some of those consist of the following.
- It includes terms from the issuer without considering the needs of the holder.
- It does not allow for any modifications or changes in the future.
- It is not transferrable from one party to another.
Conclusion
A bond indenture is a contract or agreement between the bond issuer and the holder. This contract specifies several aspects of the relationship between those parties. On top of that, bond indentures also include several essential components.
These components consist of various terms and clauses. Similarly, bond indentures can have many advantages and disadvantages.
