Bond Indentures
A legal contract that describes the form of the bond, the obligations of the issuer, and the rights of the bondholders. This legal contract is referred to as the bond indenture.
Sources of Repayment
The sources of bond repayment vary among issuers and are a key factor in determining a bond’s relative risk.
Local or regional governments may either use their taxing authority as the source of bond repayment or consider fees from infrastructure projects, such as bridges, toll roads or public transit systems, to repay interest and principal on an associated bond issue.
Investors in corporate bonds usually rely on the operating cash flows of the firm as their primary source for interest and principal payments.
Corporate bonds for issuers of higher credit quality are usually unsecured, which means these cash flows are the sole source of repayment.
Corporate issuers with less stable operating cash flows usually face more credit provisions and restrictions and may offer investors a legal claim (or lien or pledge) on specific assets as a secondary source of debt repayment in what are referred to as secured bonds.
In liquidation, the secured debtholders may receive the value of the designated assets while unsecured debtholders would only receive any funds remaining after this allocation. A junior unsecured bondholder would be the last creditor in line to receive the asset value of an issuer in default, because all secured debts and senior unsecured debts would have higher-priority claims.
Investors evaluate operating cash flows as well as these secondary claims (referred to as collateral) when assessing an issuer’s credit quality, which may include physical assets; cash flows, such as licensing fees; or financial guarantees from a third party. Issuers must weigh the benefit of providing these credit enhancements (lower borrowing costs) with the costs in terms of reduced operating flexibility.
Bond Covenants
Bondholders have limited influence over an issuer as compared to equity investors, who have voting rights. One exception to this is legally enforceable rules or bond covenants that borrowers and lenders agree on at the time a bond is issued or a loan is made.
