What is a Bond Indenture & how are Bonds Rated? What are Moody’s & Standard & Poor’s Bond Rating Systems? - Accounting Questions Answered
A bond indenture is the contract between the issuing corporation and the bond’s purchase that states the provisions of the bond issue including these terms:
- The face value of the bond (bonds comes in a denomination of $1,000 so if you own 10 bonds, you own 10 x $1,000 = $10,000.
- Coupon interest rate (the interest rate which is earned on the face value).
- Interest payment dates (when the stated coupon interest amounts will be paid to bondholders. For instance, a bond that pays interest semi-annually means the payments will be made twice a year, usually on July 30th and December 31st of a year.
- Maturity date (the date on which the full bond amount is repaid to bondholders along with the last coupon interest payment).
The yield to maturity rate is the effective market interest rate and is not included in the indenture because it is based on market conditions that change frequently, thus is assumed included in the indenture although it is not specifically stated anywhere in it.
Bond indentures are usually written by investment bankers at big banks such as Goldman Sachs, Morgan Stanley & Bear Stearns, etc. Investment bankers usually obtain ratings for bonds from one or more of the major bond rating companies including Moody’s and the Standard & Poor’s bond ratings. If a bond is rated AAA versus BAA, this indicates the ability of the bond issuing company to make the promised payments to bondholders. Bonds rated BAA3 or above by Moody’s or BBB- or above by Standard & Poor’s are called investment grade bonds. However, bonds with lower than investment grade rating of BA1 or BB+ are called junk bonds. A sample bond rating schedule from Moody’s and Standard & Poor’s is below:
Apart from the coupon interest rate, face value, maturity date, etc, the bond indenture lists the following items:
- Name of the independent trustee who will administer & oversee the bond issue including payments on coupon payment dates.
- Plans for paying off the bonds at maturity
- Provisions for paying off the bonds ahead of time
- Any collateral or security that the issuing bond company will give to the bondholder in case of default.
View 500 More Questions by Topic