A bond indenture is a legal document that lays down the terms and conditions associated with the issue of bonds by a company. It becomes a crucial document if the issuer faces financial difficulties and is unable to meet its commitment to pay interest or repay the principal amount.
What does bond indenture mean?
Companies often raise funds by issuing bonds. These are fixed-income securities that promise to pay the bondholder a specific rate of interest and to repay the principal amount after a certain number of years.
The bond indenture contains details of the bond issue. Some of the areas that it covers are:
⇨ Issue size: The amount of money that the company is planning to raise through the issue.
⇨ Coupon rate: The rate of interest payable by the company to the bondholders.
⇨ Repayment of principal: The date on which the principal will be repaid.
⇨ Steps to be taken in the event of default: The process to be followed if the company does not pay interest or repay principal on the dates that it has promised to.
It’s important to remember that a trustee is involved in the process. This third party protects the interests of bondholders and coordinates the effort against the company in the event of default.
Example of a bond indenture
Ladi Oil, an oil and gas producer faced a severe cash crunch in 2015. At that time, the company decided to issue bonds to raise $100 million. The terms of the bond indenture included the following conditions:
⇨ An interest (coupon) rate of 6% per year.
⇨ Interest payments would be made every six months.
⇨ Each bond would have a face value of $1,000.
⇨ The principal would be repaid to bondholders at the end of ten years.
The company’s bond issue was a success, and the cash infusion helped Ladi Oil to tide over its financial difficulties.
The bond indenture contains details of the rights of bondholders as well as other details of the issue.