Perpetual bonds are bonds without a maturity date. They are sometimes called “perps” or simply perpetual, and they are considered a kind of equity. One of the biggest advantages of investing in these bonds is that they provide a stream of consistent interest payments. But, it is also important to ensure that you understand how they work, how you can calculate the yield and prices, and what features they bring. Therefore, the following sections will inform you all about perpetual bonds.
How Do Perpetual Bonds Work?
As stated, perpetual bonds are securities without a maturity date. Your issuer will continue paying the interest indefinitely until the organisation is solvent. The bonds do not have a redemption date since there is no maturity date for the principal amount.
The bonds have a fixed interest rate, and you will get your interest payments as long as you hold the bond. These payments are also known as coupons, and they are paid on either a semi-annual or annual basis and are generally fixed.
The price of the bonds also keeps fluctuating depending on the market conditions. For instance, the price will reduce if the interest rates increase due to the introduction of new bonds. At the same time, the issuer has the call option and can redeem the bond during good market conditions.
How to Calculate the Price and Yield of a Perpetual Bond?
One can estimate the yield of the perpetual bond easily by using the following formula:
Current yield from the bond = (Annual bond payment / Price of the bond) ✕ 100
The price of a perpetual bond is its present value, so one can estimate it by simply finding the current value of the bond. So, follow the formula to apply a discount rate to future payments and reach the bond’s present value.
Present Value of a Perpetual Bond = Periodic Annual Coupon Payment / Discount Rate
Features of Perpetual Bonds
Perpetual bonds are desirable due to their qualities, and some of these characteristics include the following:
No Return of the Principal
These bonds do not have a redemption facility, so investors will not receive the principal amount invested. It is a risk for most investors, and consistent and long-term coupon payments can set it off.
Embedded Call Option
Most perpetual bonds come with an embedded call option that can be exercised by the issuer or the holder of the bond. It allows one to redeem the bond at any predetermined date, and it promotes liquidity.
No Yield to Maturity
The YTM, or the yield to maturity, is the return one can expect to get if one holds the bond to a certain point. But, this does not exist in perpetual bonds since they do not have a maturity date.
Infinite Coupon Payments
Perpetual benefits have the benefit of infinite coupon bonds. So, you will continuously receive interest on your investment without a hitch as long as you continue holding the bond.
Wrapping Up!
Perpetual bonds come with the benefit of consistent interests but also pose some risks. But do its coupon payments continue forever? Theoretically, the bonds offer payments that continue without a fixed date. However, several factors hinder it from continuing forever. Therefore, investors need to consider every factor when investing in perpetual bonds and ensure that they are beneficial over the long run.
FAQs About What are Perpetual Bonds
1. Who issues the perpetual bonds?
Perpetual bonds are issued by institutions that want to raise long-term capital. Financial institutions and banks offer these bonds to improve their capital along with some other corporations and governments. However, the reasons for providing these funds are different for every issuer.
2. What are some of the pros and cons of investing in perpetual bonds?
Investing in perpetual bonds has several pros, including a steady income, portfolio diversification, no maturity date, etc. Still, it also has some notable cons, including call risk, credit risk, interest rate risk, etc.
3. Why invest in perpetual bonds?
Despite its risks, perpetual bonds hold an appeal when you want diversification benefits, a steady income stream, the potential for higher yields, capital appreciation and other advantages.
