Bond Indenture

Updated on April 26, 2024
Article byWallstreetmojo Team
Reviewed byDheeraj Vaidya, CFA, FRM

What Is A Bond Indenture?

Bond indenture, also known as bond resolution, is a core legal document that acts as a contract between the bond issuer and bondholder and contains all the details related to the bond, like details of the issue, purpose of issue, obligations of the issuer of bond & rights of bondholders.

What Is A Bond Indenture

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Bond Indenture is a core legal document that safeguards the right of both investors and issuers. It contains all information related to the bond, along with the Rights and responsibilities of both issuer and bondholders. Indenture has a legal binding on all the stakeholders, and in case of any dispute or default, the indenture will be considered for any resolution.

Key Takeaways

  • The bond indenture is a contract between the bond issuer and the bondholder. It includes information about the bond’s purpose, terms, issuer’s responsibilities, and bondholders’ rights.
  • The Trust Indenture Act of 1939 mandates that every bond issued under the supervision of the U.S. Securities and Exchange Commission (SEC) has a trustee. The issuer chooses the trustee or fiscal agent for all bondholders to be a financial institution or bank.
  • All parties must be notified of the covenants for adequate transparency. The indenture is the only legally binding document in a bond dispute.
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Bond Indenture Explained

A bond indenture agreement binds an issuer and bondholders with some legal terms and conditions and makes sure the involved parties work in compliance with the same to avoid disputes at a later stage.

As per The Trust Indenture Act of 1939, any bond issued regulated by U.S. Security and Exchange Commission (SEC) must have a trustee; the issuer appoints a trustee or fiscal agent that can be a financial institution or bank which acts as a representative of all the bondholders.

To understand the bond indenture definition, it is important to know the types of bonds available in the market. Bonds can be of different types based on collaterals. Some are listed below:

  1. A collaterals trust bond is a bond against which the securities are owned by the issuer but held by the trustee appointed by the issuer.
  2.  Mortgage bonds are bonds where real estate, equipment, and other tangible assets are kept as collateral.
  3. Covered bonds are bonds issued by a bank or some mortgage institution, and a pool of assets is kept as collateral against such bonds.
  4. In default, the collateral is sold, and the amount is used to repay the collateralized bondholders.

Components

Bond IndentureIndentureIndenture is a legal agreement between two or more parties to meet their respective obligations. It is a common term used in the bond market to provide the lender and borrower with the necessary comfort in the transaction in the event of one defaulting party.read more is the legal contract document between the Bond Issuer and the bondholders. Bond Indenture includes many clauses. A few important ones that are necessarily found in any bond indenture template are listed below:

  • Purpose: Bond Indenture must include the agenda behind this bond issue.
  • Face Value: Face value is the price at which this bond will be issued.
  • Interest Rate: The interest rate given to each bondholder on the face value.
  • Payment Dates: The date or tenure when the interest will be paid to bondholders.
  • Maturity Date: The date the bond expires, and all invested amounts will be refunded to the bondholders.
  • Interest Calculation: The methodology related to calculating interest, like interest paid, is simple or compounded interest.
  • Call features: Issued Bond is callable bonds or non-callable bonds.
  • Call Protection Period: Minimum period within which the bond cannot be replaced or redeemed.
  • Non-Payment actions: This clause includes details of possible action to be taken in case of default from the issuer in payment of interest or refund of the invested amount at the bond’s maturity. Possible actions include increasing the interest rate, penalty-related details, and reduction in maturity tenure.
  • Collaterals: Some bonds are collateral-based and are Secured bond.
  • Covenant: To protect the interest of the bond issuer and holder, certain obligations are put on the bond issuer. The Covenant can be a Restrictive Covenant that restricts issuers from doing certain activities that make them less creditworthy and increase the chance of default, like paying the dividend, restriction on the purchase of property, etc. Similarly, Covenant can be an Affirmative Covenant that forces the issuer to meet certain requirements like maintaining a certain level of reserved cash, delivering audited financial statements, etc.

Example

Let us consider the following bond indenture example to understand the concept better.

There is a company XYZ that needs capital to expand its business; for that, he sought advice from his financial advisor. The company’s Financial Advisor suggested raising funds from those seeking to invest their money in such a business.

After discussing with the advisor, the company decided to approach various investors. Rather than negotiating with them individually, the company decided to create a Bond Indenture or deed of trust, which will act as a contract between XYZ and all investors (Bondholders).

Stakeholders

The following are the stakeholders in the bond indenture.

stakeholders in the bond indenture

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#1 – Issuer

The issuer generates the Bond Indenture. The indenture contains all the legal details of the bond issuer to give the investors a clear picture.

#2 – Trustee/ Fiscal Agent

The trustee is a bank or financial institution that holds the bond indenture. Trustee roles are primarily providing financial and legal assistance to bondholders. The main role of the trustee is holding the funds until payments are made to bondholders, invoicing the issuer for interest and principal paymentsPrincipal PaymentsThe principle amount is a significant portion of the total loan amount. Aside from monthly installments, when a borrower pays a part of the principal amount, the loan's original amount is directly reduced.read more, calling bondholders’ meetings, and ensuring all the terms and conditions mentioned in the Indenture are properly adhered to by the issuer.

#3 – Bondholders

The bondholder is the investor who puts his money in this debt security to receive some periodic income from interest and the principal amount at the time of maturity of the bond.

Advantages

  1. Bond Indenture is a legal document, all clauses of which apply to all the stakeholders involved in the transaction.
  2. Bond Indenture protects the interest of all the stakeholders and reduces the chance of default.
  3. Indenture clearly defines all the information related to the bond.
  4. An indenture contains information about all the rights and duties of the stakeholders, which helps avoid confusion.
  5. This document ensures all the stakeholders must be aware of the covenantsCovenantsCovenant refers to the borrower's promise to the lender, quoted on a formal debt agreement stating the former's obligations and limitations. It is a standard clause of the bond contracts and loan agreements.read more for proper transparency.
  6. Indenture is the only legal document to refer to in case of any dispute regarding the bond.

Disadvantages

  1. Indentures are non-transferable; hence, very limited options exist to exit these contracts.
  2. These contracts, once signed, are not renegotiable, so any change in the interest rate due to policy change may have financial repercussions.

Frequently Asked Questions (FAQs)

Why is bond indenture important?

The critical characteristics of a bond are specified, including the maturity date, interest payment schedule, method of calculating interest, callability, and convertible features, if any. The bond indenture outlines all the requirements that apply to the bond issue.

What is a corporate bond indenture?

Covenants are clauses intended to reduce credit risk and are frequently included in the corporate bond contract (also known as an indenture). For instance, the agreements can set a debt ceiling for the business or mandate that it maintain specific financial ratios. A default might occur if a bond’s conditions are broken.

What is a bond indenture date?

A bond indenture date means the date set forth on the cover page of the indenture

What happens if the issuer defaults on the bond indenture?

It is considered default if the issuer fails to meet its obligations in the bond indenture. In such cases, the trustee and bondholders may take legal actions to protect their interests, including pursuing remedies outlined in the contract.

This has been a guide to Bond Indenture and its definition. Here we discuss the components and stakeholders of bond indenture and examples. You can learn more about fixed income from the following articles –

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