Every bond is an agreement between the issuer and the investor(s)
A bond when it is issued, carries with it terms and conditions of the issue that specifies coupon, maturity, interest payment dates, listing, security among other things. Even more important, it lists out the rights of the issuer and the rights of the bond holder. For example, if there is call option, the issuer has the right to exercise the option while if there is put option, the bond holder has the right to exercise the option.
The rights of the issuer and the bond holders listed out in the bond issue term sheet can also called bond Covenants.
Bond covenants are extremely important to read and understand
Normally, investors take a look at the bond terms like maturity, coupon, security, put/call dates if any and go by the credit rating to judge the credit risk. However, it is important to delve into the covenants to understand bond holder rights, which comes into play when there is a possibility of default or delay in payment of interest or principal on maturity or both.
In such cases, bond holders would require to know on where they stand when a security is invoked and where they are in the priority list of payouts. Do they have access to trustees in case of any complaints against the issuer? Can a single bond holder invoke a guarantee? There can be many covenants that are not favourable to the bond holders and this has to be priced in to the coupon.
What are bond holders rights in guaranteed bonds and AT1 bonds (perpetual bonds)
A guaranteed bond is where an external entity guarantees payment of interest and principal. The entity that guarantees the bond is called the guarantor. The guarantor could be a promoter company, state or central government or even agencies like EXIM Bank or IFC or ADB. In such guaranteed bonds, it is important for the bond holder to understand the mechanism of the guarantee and the responsibilities of the trustee that invokes the guarantee if it is required.
When it comes to AT1 bonds, the bond holders must know where they stand when the issuer does not call the bond or defaults on interest or when there is a case for liquidation. Bond holders in AT1 bonds have everything loaded against them and this must be factored in to the yields.
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