What is an Indenture?
An indenture is a legal and binding agreement or document between multiple parties. These come with indented sides. These contracts bind one party to work for another for a set period of time. These were the historical uses of the word indenture. However, they have also carried over some meaning to finance and investing. Indentures are most prevalent with bonds and real estate agreements.
What is a Bond Indenture?
A bond indenture is a contract or agreement related to bonds. These contracts include a description of a bond’s features, restrictions placed by the issuer, and what happens in case of defaults. Therefore, bond indentures include various terms or clauses related to a bond. Some of these clauses are as follows.
- Purpose: A bond indenture will always define the reason why the issuer issues the bonds.
- Coupon rate: Coupon rate refers to the percentage at which investors receive periodic interest payments.
- Payment dates: Payment dates are the specific dates at which investors receive interest payments.
- Face Value: Face value is the price at which entities issue bonds or the price investors pay for them.
- Maturity Date: Maturity date defines the date on which the bond will expire. It’s also the date when investors will receive the face value of the bond.
- Interest calculation: Interest calculation includes a description of the formula used to calculate the interest payments.
- Call features: It shows the rights of the issuer to buy back bonds on the maturity date.
- Conversion features: It shows if investors have the option to convert the bonds into the common stock of the issuer.
- Non-payment actions: This clause defines what will happen if the issuer defaults on the interest or principal repayments. It may include penalties or an increase in interest rates.
- Collateral: Collateral includes terms about whether the bond has collateral behind it.
- Covenant: It includes a list of covenants that issuers must follow while the bonds are outstanding and how to calculate those covenants.
Apart from these, bond indentures may also define certain other elements of a bond or give information.
What are the advantages of Bond Indentures?
Bond indentures are legal documents by which all parties must abide. Like any other contracts or agreements, bond indentures define various things related to the bond. It, in turn, helps protect the rights of all stakeholders associated or involved in the transactions. Since they include the rights of all stakeholders, bond indentures also help avoid any confusion.
Bond indentures are also crucial for defining covenants with transparency. In case of any disputes between stakeholders, the bond indenture can provide a reference point for a solution.
What are the disadvantages of Bond Indentures?
Indentures can also create some problems for stakeholders. Firstly, these are well-defined contracts that, once signed, are unchangeable. Therefore, it can have financial consequences in case of any terms going against any stakeholder. Similarly, they are non-transferable. That means that all involved parties have limited options to exit the contract.
Conclusion
A bond indenture is a document that defines various features or characteristics related to a bond. For example, it may include the bond’s purpose, coupon rate, payment dates, face value, maturity date, collateral, covenants, etc. Bond indentures can have various benefits but may also come with some drawbacks.
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