An issuer who is stable has more confidence that they will not default and can thus add a closed-end indenture in the bond’s terms. Indenture can be used by an investor—along with interest rate and time to maturity—to assess risk and make a decision about investing in a specific bond issue. For example, a trust indenture may indicate whether an issued bond is callable. If the issuer can “call” the bond, the indenture will include call protection for the bondholder, which is the period during which the issuer cannot repurchase the bonds from the market. After the call protection period, the indenture may list the first call dates and any subsequent call dates that the issuer may exercise its right to call. The call premium, that is, the price that will be paid if the issuer repurchases the bond is also indicated on the trust indenture.
It specifies the important features of a bond, such as its maturity date, the timing of interest payments, method of interest calculation, callability, and convertible features, if applicable. A bond indenture also contains all the terms and conditions applicable to the bond issue. Should a conflict arise between the issuer and bondholder, the indenture is the reference document utilized for conflict resolution.
Safeguard for Investors and Issuers
They are conservative investments that provide investors with stability and income. They represent loans advanced by the investor to the bond issuer—the issuer promises to repay the investor the principal balance invested along with any interest payments by a specified date. A bond indenture is a legal contract issued to lenders that defines commitments and responsibilities of the seller and buyer. Historically, indenture has also referred to a contract binding one person to work for another for a set period of time (indentured servant), particularly European immigrants. In modern-day finance, the word indenture most commonly appears in bond agreements, real estate deals, and some aspects of bankruptcies.
Definition and Importance of Bond Indentures
Almost all indentures include subordination clauses that limit the amount of additional debt that the issuer can incur, and that dictate that all subsequent debts are subordinated to prior debts. Without such restrictions, an issuer would theroretically be allowed to issue an unlimited amount of debt, increasing bondholders’ exposure to default risk. A bond that is callable can be redeemed before the maturity date for par or face value. Redeeming a callable bond is only possible at a specific price and when certain conditions are in place. Convertible bonds include the option to trade the bond for a set amount of the issuing company’s stock.
This clause contains the maturity date of the bond, when the face amount of the bond will be paid to bondholders. Shaun Conrad is a Certified Public Accountant and CPA exam expert with a passion for teaching. After almost a decade of experience in public accounting, he created MyAccountingCourse.com to help people learn accounting & finance, pass the CPA exam, and start their career.
If the company breaks the agreement set forth in the bond indenture, the trustee can sue the company on behave of the bondholders. A copy of it must be filed with the Securities and Exchange Commission (SEC) for corporate bonds with aggregate principal issues of at least $5 million. Corporate issues for less than $5 million, municipal bonds, and bonds issued by the government are not required to file trust indentures with the SEC. Of course, these exempted entities may choose to create a trust indenture to reassure prospective bond buyers, if not to adhere to any federal law. A trust indenture also includes the characteristics of the bond, such as maturity date, face value, coupon rate, payment schedule, and purpose of the bond issue. One section of the trust indenture dictates the circumstances and processes surrounding a default.
Types of Indentures
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. Closed-end indentures are only invoked if the bond issuer defaults, which means that indenture is crucial in a situation of financial instability for the bond issuer. If the bond issuer defaults, a closed-end indenture ensures the bondholders will have the only claims on the collateral, making individual tax preparation their bonds the most senior security.
- Failure to meet the payment requirements calls for drastic penalties, including liquidation of the issuer’s assets.
- Bonds are issued to lenders or investors to raise money for a corporation or governmental body.
- Many of the current rules regarding trust indentures were established by the Trust Indenture Act (TIA), a piece of legislation passed in 1939 to protect bondholders and investors.
- A bond indenture may also be called a bond resolution, a bond contract, or a deed of trust.
BUS202: Principles of Finance
Bonds are issued to lenders or investors to raise money for a corporation or governmental body. To issue a bond, the issuer hires a third-party trustee, usually a bank or trust company, to represent investors who buy the bond. The agreement entered into by the issuer, and the trustee is referred to as the trust indenture.
He is a CFA charterholder as well as holding FINRA Series 7, 55 & 63 licenses. He currently researches and teaches economic sociology and the social studies of finance at the Hebrew University in Jerusalem.
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). Other terms and conditions related to the bond will be listed, as well as the consequences from nonpayment. Nonpayment may result in severe penalties, including liquidating the assets of the issuer. The bondholders can also voice complaints to the trust in an effort to raise legal action against the issuing company. The yield-to-maturity rate is omitted from a bond’s conditions because it is assumed to be the prevailing market interest rate when the bond is issued.
The what is a natural business year indenture contains all the legal details of the bond issuer to give the investors a clear picture. This clause can include a number of possible actions, such as increasing the interest rate, creating a cumulative interest liability, or accelerating the maturity date of the bond. For example, if a bond issuer does not make coupon payments by any scheduled date, then the maturity date of the bond issuance is automatically accelerated. This presents the issuer with a strong incentive to make all coupon payments on a timely basis. Many of the current rules regarding trust indentures were established by the Trust Indenture Act (TIA), a piece of legislation passed in 1939 to protect bondholders and investors.
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. My Accounting Course is a world-class educational resource developed by experts to simplify accounting, finance, & investment analysis topics, so students and professionals can learn and propel their careers. Adam Hayes, Ph.D., CFA, is a financial writer with 15+ years Wall Street experience as a derivatives trader. Besides his extensive derivative trading expertise, Adam is an expert in economics and behavioral finance. Adam received his master’s in economics from The New School for Social Research and his Ph.D. from the University of Wisconsin-Madison in sociology.
Yarilet Perez is an experienced multimedia journalist and fact-checker with a Master of Science in Journalism. She has worked in multiple cities covering breaking news, politics, education, and more. Call option allows issuer to repurchase bond before maturity; put option allows holder to sell bond back. Total return expected if bond held to maturity, accounting for interest payments and price changes. This clause contains an explanation of the circumstances under which bonds can be converted into the common stock of the issuer, and at what conversion ratio.
For example, if a conflict of interest comes up involving the trustee’s role as a fiduciary, in certain trust indentures, the issue must be resolved within 90 days. Bond indentures are vital legal contracts that define the terms of bond issues, ensuring the protection of investors and issuers in the financial market. They detail the bond’s face value, interest rate, maturity date, and include covenants that govern the issuer’s financial activities to mitigate risk. Understanding these documents is essential for finance professionals, as they dictate the conditions under which bonds are traded and upheld. A bond agreement is described as a contract used for privately placed debt.