Perpetual Bonds – How Do They Work?

Perpetual bonds are bonds that are issued with no maturity date. These bonds are also called “Perps” or “consol,”. As the name suggests, these bonds can work for perpetuity. Investors would receive coupon payments as long as they hold the investment in these bonds.

These bonds present a fraction of the total bond market today. Only large banks and governments issue these bonds. Bond issuers require high credit ratings to issue these bonds. These bonds offer a higher yield than other types of bonds for the same characteristics.

Deeper Definition

A perpetual bond pays coupon payments for perpetuity and comes with no maturity date. Investors receive coupon payments as long as they hold the investment. However, the bond’s principal amount does not reduce over time and has no maturity date.

Bond issuers of perpetual bonds do not come under any obligation to repay the principal amount of the bond to the investors. Instead, the bond coupon payment would continue for perpetuity. However, bond issuers can add a clause to call the bond after a specified period, such as 10 or 15 years from the issuing date.

How Do Perpetual Bonds Work?

Theoretically, perpetual bonds will never expire as they do not have a maturity date. However, that isn’t the case in practice. Bond issuers are exposed to the interest rate risk if they do not call these bonds. Hence, they often call a bond and issue a new one with similar characteristics and a new interest rate.

They do not repay the principal amount to the issuers. Thus, bond issuers require high credit ratings to issue these bonds. As a result, investors consider these bonds a risky investment unless the issuer is a reputable entity. That is one reason not all corporate entities issue perpetual bonds.

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Let us see how we can calculate the present value and yield for investors on these bonds.

Calculating Present Value of Perpetual Bonds

The present value of perpetual bonds can be calculated with the present value formula of perpetuity.

Present Value = D/r

Where:

D = annual coupon payment         

r= coupon rate (annual)

For example, suppose a perpetual bond pays $ 50,000 in annual coupon payments and has a coupon rate of 5%.

Present value = 15,000/0.05 = $ 300,000.

The present value of the bond is directly affected by the coupon rate. The annual coupon amount also depends on the coupon rate. Hence, if the coupon rate changes, the present value of this bond will change.

Calculating Yield on Perpetual Bonds

Investors can also calculate the yield on perpetual bonds with the same set of data. Now, let assume that the par value of the bond is $100. It is trading at a discount, and its current market price is $95.

We can calculate the yield on a perpetual bond with the following formula:

Current Yield = (Annual Coupon Amount in Dollars/market value of the bond) × 100

Current Yield = {(0.05 × 100) / 95} × 100 = 5.26%

Investors would expect a yield of 5.26% by investing in this bond with a par value of $100 and a market value of $95. The yield would change with a change in the coupon rate or the market value of the bond.

Special Considerations with Perpetual Bonds

The main appeal with perpetual bonds is infinite coupon payments for investors. However, it doesn’t mean the coupon payments would go infinite practically. Bond issuers can call these bonds after a specified period, such as five or ten years. The redemption is solely at the discretion of the bond issuers and not the investors.

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Apart from redemption risk, investors must consider the interest rate risk as well. They can lock their investments for a long period in perpetual bonds that offer low-interest rates while market interest rates rise.

Benefits of Perpetual Bonds

These bonds offer several benefits to bond issuers and investors.

  • Investors receive steady income through higher coupon rates consistently.
  • Some perpetual bonds adjust interest rates over time to match the inflation rate.
  • Bond issuers do not need to repay the principal amount unless they redeem the bond.
  • Bond issuers can add a clause of redemption after a specified period and can call the bond at a favorable time.

Limitations of Perpetual Bonds

These bonds also come with some risks and limitations.

  • Investors face interest rate risks with perpetual bonds.
  • Investors also face redemption risk as issuers would often redeem these bonds at a favorable time for them.
  • If interest rates increase, they lose value; hence investors would lose money.
  • Investors face the credit risk of the bond issuers.

Final Thoughts

Perpetual bonds offer a steady income for investors. There is no obligation for issuers to repay the principal unless they call the bonds. Theoretically, the coupon payments would continue infinitely. However, issuers can redeem these bonds after a specified period, such as five or ten years.

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