Finance

Perpetual Bonds

Perpetual Bonds

Perpetual bonds, also known as perps, are bonds that have no maturity date. Perpetual bondholders like any other bondholders are paid interest via coupon payments but the bond’s principal amount does not come with a set date for repayment. The coupon payments are made for perpetuity.

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How do they work?

Perpetual bonds are a form of debt obligation wherein the issuer does not have to pay the principal amount provided they make coupon payments to the bondholders perpetually. Perpetuals are similar to annuities as in an annuity too, the holder receives payments for perpetuity.

A perpetual bond issuer has the option to call or redeem the bond at any point after a predetermined time like five years from the issue date. Hence, some holders do get their principal amount eventually. The redemption time is flexible according to when the issuer can afford to redeem the bond. But they are not obligated to return the principal amount.

Yield calculation:

The yield of a perpetual bond = ( Total amount of coupon payments received annually / Market price of the bond)   x 100

Example:

Suppose you invest in a $100 perpetual bond with a coupon payment of  $8 per year.

Current yield = (8/100)*100 = 8%

The bond has a current yield of 8%

Benefits:

  • Fixed income stream: There is a regular, reliable stream of income through coupon payments that are received annually. The stream of income is reliable as is it long term.
  • Higher interest: Compared to other types of bonds, perpetual bonds have higher interest rates and yield. This is because they are a subordinate debt of larger institutions and also provide a notional sense of safety.
  • No reinvestment hassles: These types of bonds save a lot of the investors time and energy which often gets wasted in searching for new bonds and securities to reinvest in.

Drawbacks:

  • Credit risk: The bondholders have a perpetual exposure to the issuer’s credit risk. This exposure lasts as long as the bond lasts.
  • Interest rate risk: there is a risk that the investment will lose its value if the interest rates increase higher than the bonds coupon rate.
  • Missing out investment opportunities: Because the investor can’t withdraw the sum, there is a drawback that the investor could’ve invested the sum in other lucrative opportunities when there is a rising interest rate.
  • Another drawback is that when the interest rates are in the favor of the investor, the issuer can call back the bond.

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Conclusion:

Perpetual Bonds are bonds that do not have a maturity and redemption date. The issuer pays annual coupons to the bondholder for perpetuity. The issuer has the option to pay back the principal amount after a certain date. These types of bonds are generally taken by people who have retired and can use the reliable stream of regular income.

 

Author – Abha Shetty

About the author – Abha is a second-year BMS student and FRM level 1 candidate. She is very intrigued by the world of financial markets and hopes to master the art of investing and trading.

 

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