Bond indenture

Definition

A bond indenture is a legal contract between a bond issuer and the bondholders that outlines the specific terms and conditions of the bond. This document includes details such as the interest rate, payment schedule, maturity date, and any covenants that must be adhered to by the issuer. Understanding the bond indenture is crucial for both issuers and investors as it governs the rights and obligations of each party involved in the bond transaction.

5 Must Know Facts For Your Next Test

1. The bond indenture serves as a crucial reference point for both issuers and investors when evaluating the terms and risks associated with a bond.
2. Breach of covenants outlined in the bond indenture can lead to default, giving bondholders certain rights, including potential legal actions to protect their investments.
3. Bond indentures can vary widely in their terms, impacting the pricing and marketability of different bonds.
4. In addition to basic terms, some bond indentures may include conversion features that allow bondholders to convert bonds into shares of stock under certain conditions.
5. The trust indenture act requires certain bonds issued in the U.S. to have an indenture agreement that protects the interests of bondholders.

Review Questions

• How do covenants in a bond indenture protect the interests of bondholders?
  • Covenants in a bond indenture are designed to protect bondholders by imposing restrictions and obligations on the issuer. These may include maintaining specific financial ratios or limitations on additional borrowing. By ensuring that the issuer adheres to these financial metrics, covenants help safeguard the interests of bondholders and reduce the risk of default, creating more stability in their investment.
• Evaluate how different terms outlined in a bond indenture can affect an investor's decision to purchase a particular bond.
  • Investors consider various terms in a bond indenture before making a purchase, as these details significantly influence risk and return. Factors such as interest rates, maturity dates, and covenants play critical roles in assessing whether a bond aligns with an investor's financial goals. For instance, favorable covenants may lower risk perceptions, while unfavorable call provisions might deter investors due to potential early redemption.
• Assess the implications of breaches in a bond indenture on both issuers and investors within the context of capital markets.
  • Breaches in a bond indenture can have severe implications for both issuers and investors. For issuers, failing to meet covenant requirements could trigger defaults, leading to increased scrutiny from creditors and possible legal consequences. Investors, on the other hand, may face financial losses if they need to sell their bonds at a discount due to perceived increased risk. Such events can lead to wider capital market repercussions, affecting overall investor confidence and liquidity.

Related terms

covenants: Covenants are specific clauses within a bond indenture that impose certain obligations on the issuer, such as maintaining financial ratios or limiting additional debt.

face value: Face value is the nominal or par value of a bond, which is the amount that will be paid back to the bondholder at maturity.

call provision: A call provision is a clause in a bond indenture that allows the issuer to redeem the bond before its maturity date under specified conditions.