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Long-Term Debt & the Indenture Agreement

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  • 0:04 Bonds as Long-Term Debt
  • 1:25 Indenture Agreement
  • 3:48 Lesson Summary
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Lesson Transcript
Instructor: Ian Lord

Ian is a real estate investor, MBA, former health professions educator, and Air Force veteran.

Bonds present an option for investing in long-term debt. Let's take a look at bonds and the indenture agreement that states key details specific to it, such as seniority, repayment, call provision, and protective covenants.

Bonds as Long-Term Debt

Brian is considering purchasing bonds as a way of investing in long-term debt. This lesson will help Brian understand how investing in long-term debt works and how the indenture agreement provides clarification of the bond contract terms.

In simple terms a bond is a loan made by an investor to a company or government. The organization issues the bond with a specified coupon or interest rate that will be paid periodically to the investor. At a designated time in the future the bond will mature, at which point the organization returns the original purchase price of the bond. The time from issue until the maturity date is called the duration.

Bonds with a duration of greater than 12 years are considered long-term debt by the U.S. government. It is typical to see bond durations of 30 years, although 50-year bonds exist as well as bonds which have no maturity date.

Like stocks, a bond is a type of financial security. A security is a tradable and intangible financial asset. This means a security is something that by itself is not a physical property, but instead a contract to certain rights. A bond represents debts and stocks represent ownership of a company. The details of the bond contract are contained within a document known as an indenture agreement.

Indenture Agreement

What happens if Brian has a question about the terms of the bond he owns or is considering purchasing? In the world of bond investing the contract describing the specific details of the bond is called an indenture agreement. In the event of a legal conflict between the organization and the bondholder, the contract serves as a source document for policies that must be adhered to. Let's learn about some of these policies in an indentured agreement.

If the organization issuing the bond finds itself bankrupt or sold, seniority comes into play. The seniority of the bond will determine in which order the debts are paid. As a bond investor, Brian automatically has seniority over the shareholders (those with stock in the company). If the company goes bankrupt, the bondholders, who are creditors of the company, will be paid off before the owners.

How and when Brian can expect repayment of his investment is detailed in the indenture agreement. Repayment is the maturity date along with the amount paid at maturity and it is a key piece of information. Investors want to know if and when the bond pays out interest, or if the bond is purchased at a below face value price so that all the profit is made at maturity.

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