BAJAJ BROKING
September 19, 2024
4 mins read
Perpetual bonds are the bonds that are issued on a perpetual basis. Simply put, these bonds do not have a repayment date. Hence, their issuer does not have to pay the principal back to the investors. Instead, the issuer pays interest on such bonds forever to the investors. As these bonds are issued on a perpetual basis, only those investors who invest for an extremely long period should consider investing in them. Such bonds are mostly issued by the government, government-related agencies, banks, and some corporations.
As the name suggests, “perpetual bonds” are issued on a perpetual basis. The issuers of such bonds do not pay the amount originally invested in them by investors back to those investors. However, the issuers pay interest on them forever to the investors.
Therefore, you should invest in such bonds only if you are comfortable with the idea of receiving a fixed interest forever and you are fine with your principal never coming back to you.
Typically, such bonds are issued by the government, government agencies, banks, and a few corporations. They are a niche instrument. Hence, only a few organisations issue them and a few investors invest in them. Read this blog because it explains the meaning of perpetual bonds, the risks and benefits associated with such bonds, and many related aspects.
A perpetual bond is a kind of debt instrument with no term of maturity. If you have invested in a perpetual bond, you can never redeem your investment. Then, why should you invest in such a bond? A perpetual bond pays you a steady interest income forever. That’s why they are known as perpetual bonds.
As you can never redeem a perpetual bond, it is similar to an equity instrument because such instruments cannot be redeemed. However, in the case of a perpetual bond, the issuer is under a legal obligation to pay you interest forever, while in the case of equity, the issuer is under no such obligation. Now that you’ve understood what perpetual bonds are, let’s delve deeper into this topic.
As perpetual bonds are quite different from other instruments, we should thoroughly understand how they work. The fact that perpetual bonds do not repay the principal makes them an attractive instrument for issuers. However, precisely for this reason, investors should be careful about investing in such bonds.
When an investor invests in a perpetual bond, he is supposed to receive interest income forever. Even when that investor expires, his legal heirs are supposed to receive interest income and this goes on forever.
For investors, the only benefit of investing in such bonds is that they assure an interest income for perpetuity. As these bonds are not redeemable, an investor can never get his principal back. Let’s say that an investor invests in a perpetual bond with Rs. 1,000 face value at a 7% coupon rate. In this case, he will get Rs. 70 yearly interest forever but will never get Rs. 1,000 principal back.
However, there can be exceptions to it. Often perpetual bonds are callable. This means that their issuer has the option to redeem them at any point after a specific duration. For example, an organisation can issue a perpetual bond that can be redeemed at any time after the completion of five years from the issuing date.
Even in this case, the issuer has the option (not an obligation) to pay the principal at any time convenient to him after five years. Perpetual bonds are a niche type of instrument. If you invest in such bonds, you are expected to forget about your principal amount. Hence, you should have the utmost trust in the issuer.
As these bonds are not redeemable, investors feel comfortable investing in them only if they are issued by a reputed organisation. Therefore, only the government, government entities, banks, and some corporations issue such bonds.
It’s pretty simple to calculate the price of a perpetual bond, as you need only two inputs for it. The first input is the fixed coupon interest. Let’s say that you get Rs. 1,000 per year interest from a perpetual bond. So, Rs. 1,000 is the first input.
The other input is the discount rate. In this case, the discount rate means the rate at which the time value of money gets eroded over a period of time, which is typically the rate of inflation. Assume that it is 5%. To calculate the price of a perpetual bond, you need to divide its yearly interest income from its discount rate, using this formula.
Price of perpetual bond = Annual interest / Discount rate = 1,000 / 0.05 = Rs. 20,000.
Prominent advantages of investing in perpetual bonds are explained below:
Steady stream of income: When you invest in a perpetual bond, you get a fixed stream of income in the form of interest payments till perpetuity. If you are sure of the creditworthiness of the bond issuer, you can invest in such bonds and relax for the rest of your life because you will be getting fixed interest.
Get higher interest than other bonds: Typically, a perpetual bond offers higher interest than other bonds. If not for this feature, people wouldn’t invest in a perpetual bond.
The risks associated with investing in perpetual bonds are described below:
Credit risk of the issuer: If the issuer of a perpetual bond goes insolvent, you won’t get interest income from such bonds. Hence, investors in such bonds are exposed to credit risk. You face a higher degree of this risk in perpetual bonds than in other bonds because your investment in such bonds is forever. Hence, you and your future generations should be concerned about the credit risk of the issuer forever.
Interest rate risk: These bonds offer a fixed rate of interest. Even if inflation moves up, you’ll get the same interest. If inflation for a certain period is higher than the interest you are getting on a perpetual bond, you’ll earn a negative rate of interest. Hence, you face interest rate risk while investing in perpetual bonds.
Call option can work as a disadvantage: Often perpetual bonds are callable, which means their issuer can redeem them after a specified period. The issuer can redeem them anytime after the said period is over, which brings in an element of uncertainty, which exposes investors to risk. For example, you may invest in a perpetual bond on a perpetual basis, but if it has a call option that’s exercisable after five years, the issuer can redeem it at any time after five years.
The main differences between perpetual bonds and other fixed income bonds are explained below:
Criteria | Perpetual Bonds | Other Fixed-Income Securities |
Term of maturity | These bonds are issued for perpetuity. Hence, they don’t have a term of maturity. | These securities are offered for a fixed term. |
Principal repayment | As these bonds are perpetual, their principal is not repayable. However, if the issuer exercises a call option, he has to pay back the principal to the investors. | At the completion of their fixed term, the issuer of such securities is under a legal obligation to pay back the principal to the investors. |
Issuer | Such bonds are usually issued by the government, governmental agencies, banks, and a few corporations. | Such bonds are issued by all kinds of issuers, including the government, public sector undertakings, private companies, etc. |
The issuers of perpetual bonds don’t pay the principal back to the investors. However, they pay interest forever on such bonds. Hence, perpetual bonds are only meant for those investors who want to hold an investment for an extremely long period. Such investors should invest in perpetual bonds and mostly forget about them. After investing, the only two factors they should be concerned with are: whether they are receiving interest regularly and whether the interest income is higher than inflation.
If they are not getting interest income or if the inflation rate is considerably higher than the interest, they will have to find ways to deal with the problem. However, it may not be easy to find a solution to such a problem. Hence, investors are not advised to park a significant portion of their portfolio in perpetual bonds.
While it’s not difficult to understand the meaning of perpetual bonds, it’s important to appreciate that such bonds are not everyone’s cup of tea. In other words, not all investors find them suitable for investment. This is because not everyone invests for an extremely long period.
Those who want to invest in perpetual bonds should thoroughly analyse the creditworthiness of the issuer. If they are certain that the issuer can pay interest forever, they can consider investing in such bonds, if it suits their investment objective.
Disclaimer: Investments in the securities market are subject to market risk, read all related documents carefully before investing.
This content is for educational purposes only. Securities quoted are exemplary and not recommendatory.
For All Disclaimers Click Here: https://bit.ly/3Tcsfuc
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Bonds which do not have a term of maturity, which means their issuer does not have to pay their principal back and instead has to pay interest forever are called perpetual bonds. Meanwhile, regular bonds have a date of maturity, which means their issuer has to pay the principal to their investors on that date.
The interest on perpetual bonds is paid forever. Usually, it’s paid once in a year (annual basis) or twice in a year (semi-annual basis).
There are two main advantages of investing in such bonds. One, perpetual bonds offer a steady stream of interest income. Two, typically, they offer a higher interest rate than other bonds.
If the issuer of a perpetual bond goes insolvent, he will not be able to pay the interest due on them. If the inflation increases to such an extent that it's higher than the interest payable on a perpetual bond, then the investors of such bonds will earn a negative return after considering the inflation.
Only those investors who want to earn a steady interest income for an extremely long period of time should think of investing in perpetual bonds. This is because such bonds do not pay back the principal to investors in most cases, while they pay interest forever.
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