A bond indenture (also called “indenture” or “trust indenture”) is an agreement made between a bondholder and an issuer to regulate the terms of payouts. It determines the amount of invested funds, bond maturity date, and the method of calculating the interest rates.
Explanation:
A typical bond indenture includes conditions for issuing bonds, which are determined by the issuer’s financial circumstances, the probability of the issuing company making payments on its obligations, and the ownership rights of the issuer and the bondholder. Bond indentures can later be used by the parties to resolve any conflicts that might arise regarding the bond terms and conditions.
Companies usually draw up bond indentures when they decide to issue bonds. If a company does not have this contract, federal and state governments will withhold permission to issue bonds. In addition, governmental authorities define the number of bonds that can be issued.
Companies do not make agreements with each bondholder separately. All bondholders have a representative in common, a trustee or a third party (i.e., a bank or another financial institution) to whom a bond loan is issued. After the bond indenture has been signed, the trustee has the right to sue the issuing company in case of a violation of the terms of the agreement. Furthermore, bondholders can only file complaints against the issuing company with a trustee.
The trustee’s area of responsibility includes investment management. The trustee or third party monitors the payouts of interest rates and the fulfillment of clauses prescribed in the bond indenture. If the issuing company does not fulfill its obligations, it can be punished with significant fines or even the liquidation of the company’s assets.
Sometimes issuing companies purchase bond insurance, which guarantees bondholders the payouts of interest rates and the repayment of the principal amount at maturity date, in case of default. The cost of such insurance, sometimes called “financial guarantee insurance,” depends on the financial stability of the issuing company.