What is a Bond Indenture?

A bond indenture is the contract associated with a bond. The terms of a bond indenture include a description of the bond features, restrictions placed on the issuer, and the actions that will be triggered if the issuer fails to make timely payments. The bond indenture is the core legal document referenced by the bond issuer and investors when there is a dispute regarding bonds.

Contents of a Bond Indenture

A bond indenture will likely include the clauses noted below:

Purpose. This clause states the reason why the bonds are being issued.
Interest rate. This clause contains the interest rate stated on the face of the bond.
Interest calculation. This clause ensures clarity and consistency in the calculation of interest payments and typically includes the following key details:
- Interest rate. The nominal or coupon interest rate is stated as a fixed percentage (e.g., 5% annually) or as a variable rate (e.g., LIBOR + 2%). For variable-rate bonds, the clause specifies how and when the rate will be reset.
- Interest accrual basis. Describes the day count convention used to calculate interest. For example, it may be based on the actual number of days in the period and year, or an assumption that each month has 30 days, and a year has 360 days.
- Payment frequency. Specifies how often interest payments will be made, such as annually, semi-annually, quarterly, or monthly.
- Commencement of interest. Details when interest begins to accrue, often starting from the issue date or another specified date.
- Payment dates. Specifies the exact dates when interest payments are due.
- Calculation of interest for partial payments. Provides instructions for prorating interest if the first or final payment period is shorter than the regular period.
- Default interest. Includes provisions for a higher interest rate or penalty if the issuer defaults on payment.

Payment dates. This clause contains the dates when interest payments will be made to bondholders.
Maturity date. This clause contains the maturity date of the bond, when the face amount of the bond will be paid to bondholders.
Call features. This clause explains the rights of the issuer to buy back bonds prior to the maturity date.
Conversion features. 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.
Covenants. This clause contains a list of the covenants to which the issuer will be subjected while the bonds are outstanding, and how the covenants are calculated.
Non-payment actions. 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.