What is a Perpetual Bond?

A perpetual bond is also called a “consol” or “perp.” It has no maturity date. Unlike other bonds, where on a certain date the principal invested gets returned to the investor, perpetual bonds pay interest forever. In the case of perpetual bonds, interest is provided to the holder for the duration they hold the bond, but the principal is never returned to them. Perpetual bonds are a type of long-term financing in which corporations or governments issue them to raise long-term capital with no obligation to repay the principal.

Understanding Perpetual Bonds

Perpetual bonds are unique in the world of fixed-income securities because they have no maturity date. This makes them more akin to equity than traditional debt. Investors are attracted to perpetual bonds for the steady income stream they provide, as these bonds pay a fixed rate of interest for as long as they are held. However, the trade-off is that the principal is never returned, and the bond’s price can fluctuate significantly in the market, particularly in response to changes in interest rates.

The value of a perpetual bond is largely influenced by the interest rate environment. If interest rates rise, the value of a perpetual bond typically falls, since newer bonds might offer higher yields. Conversely, if interest rates drop, the value of perpetual bonds may increase, as their fixed-interest payments become more attractive. Additionally, perpetual bonds often carry higher interest rates to compensate investors for the increased risk associated with the lack of principal repayment. 

These bonds are generally used by issuers who seek to maintain a lower debt profile while securing long-term financing. Investors, on the other hand, view perpetual bonds as a way to earn steady income over an indefinite period, making them suitable for those with a long-term investment horizon.

Now that we understand what is a perpetual bond, let’s explore how it works.

Example of a Perpetual Bond

Perpetual Bond Example: Perpetual bond payments are rationally priced similarly to stock dividend payments since they both provide some form of return for an endless duration.

Therefore, the price of a perpetual bond is equal to the fixed interest payment, or coupon amount, divided by a predetermined discount rate that indicates the rate of depreciation of money over time (due in part to inflation). Over time, the ostensibly fixed coupon amounts’ true value is reduced by the discount rate denominator, until this value equals zero. Because of this, perpetual bonds can be given a finite value, which in turn indicates their price, even if they have no maturity date and always pay interest.

Features of Perpetual Bond 

Perpetual Bonds have no maturity date, due to this they have certain distinct features which are mentioned below:

1. Infinite coupon payment: The defining advantage of infinite coupon payment typifies the characteristics of perpetual bonds. As long as the bond remains in your hands, you will continue to receive the interest on your investments, with no exception whatsoever.

2. Embedded call option: Since perpetual bonds do not have any maturity date, most of them carry an embedded call option that the issuer can exercise. It introduces liquidity and allows the issuer to call back or redeem the bonds at a pre-defined date.

3. No Yield to Maturity (YTM): This is, in essence, the yield or return one is likely to gain if he holds the bond to maturity. However, the problem is that because a perpetual bond does not have a maturity date, it consequently has no YTM.

4. No return of the principal: The lack of any redemption facility means that investors will never get the money that they invested in. This is a huge risk for most investors, which can only be set off by long-term and consistent coupon payments.

Who Issues Perpetual Bonds?

Perpetual bonds are typically issued by large, stable institutions willing to raise long-term capital. Banks and other financial institutions issue these bonds as a means of strengthening their capital base, given that regulatory requirements at times stand in favor of holding perpetual debt to count toward Tier 1 capital, providing a financial stability buffer.

Such bonds for raising funds for long-term projects or restructuring their current debt are also offered by companies with good credit ratings, taking advantage of the fact that these bonds are perpetual in nature to avoid pressures for refinancing.

Governments issue perpetual bonds to raise finances for infrastructural projects that take a very long period of time or manage debt in the public sector. This provides stable funding with no obligation to repay the principal.

The fact that banks, companies, and governments deploy this capital instrument strategically underlines their importance to financial stability and long-term investment.

Benefits Of Investing in Perpetual Bonds 

Here are some key benefits of investing in perpetual bonds:

• Perpetual bonds involve a periodic income flow in a monotone manner. They may, therefore, be appealing if one is thinking of long-term monetary security. As such, retirees may find them especially useful.
• Perpetual bonds are generally considered to be fairly safe investments with limited market risks. As such, they are ideal investment tools for the risk-averse investor. However, just like all investments, safety notwithstanding, credit ratings and the financial stability of the issuer also have to be seriously considered before a decision to invest is made.
• Issuers usually issue perpetual bonds with higher interests compared to those with due dates. In India, perpetual bond yields are generally 200–300 basis points above the yield of government bonds. They, therefore, are an excellent avenue for higher returns.
• Perpetual bonds do not have reinvestment risks, unlike bonds that are issued for a specified maturity date. You would not need to seek alternative ways of investing when the bond matures.

Disadvantages of Investing in Perpetual Bonds

Investing in perpetual bonds has its advantages, but there are also some drawbacks to consider before putting your money into them. Here are the downsides you should know:

• You are subject to the issuer’s credit risk when you own perpetual bonds. If the issuer’s creditworthiness declines, interest payments might not be made on time.
• Interest rate risk can affect perpetual bonds. In a rising interest rate environment, these bonds lose appeal and could see a decline in market value.

Who Should Invest in Perpetual Bonds?

Depending on the investor type, financial goals, and risk appetite, investments in perpetual bonds may therefore be suitable for some types of investors. Key highlights that may make these bonds suitable for a class of investors include:

Income-Seeking Investors: These bonds are ideal for investors seeking regular income. The regular coupon payments offer a reliable source of income that could be attractive to retirees or those who need consistent cash flows.

Long-term investor: These bonds are suitable for investors with a long-term investment horizon and willing to hold the bond for the long term. The indefinite nature of the bond corresponds with a long-term horizon.

Risk-averse Investors: They come with some risks but, speaking generically, they are safer compared to equities. Investors after relatively stable investments with fixed-income features find perpetual bonds attractive.

Diversified Portfolio: These bonds offer different risk-return profiles from traditional bonds and equities, therefore offering diversified portfolios for the investors who so desire.

Institutional Investors: Large institutional investors include pension funds and insurance companies that invest in these bonds to help match their long-term liabilities and generate predictable income.

Calculating the Yield on a Perpetual Bond

The current yield on a perpetual bond is equal to the total amount of coupon payments received annually, divided by the market price of the bond, times 100 (to provide the interest rate/yield percentage figure).

Example:

Investors can calculate the yield return they can expect to realize from investing in a perpetual bond as follows:

So, for example, assume that you invested in a perpetual bond with a par value of ₹1,00,000 by purchasing the bond at a discounted price of ₹95,000. You receive a total of ₹8,000 per year in coupon payments.

Current Yield = [8000 / 95,000] * 100 = 0.0842 * 100 = 8.42%

The current yield from the bond is 8.42%.

Conclusion

A perpetual bond is an investment that assures steady, long-term income without a maturity date. While they can be an attractive choice for both income-seeking and risk-averse investors, it is worth considering certain risks such as those involving credit and interest rate fluctuations. At the same time, a thorough check on the financial stability of the issuer will be needed to ensure the dependability of the ongoing interest payments. Perpetual bonds could be an optimum addition to a diversified portfolio of investors whose investment horizon is long-term and whose craving for returns is consistent. However, before deciding to invest, it’s important to understand how to calculate the yield and how a call option might affect your investment.

FAQs on Perpetual Bonds