FLASH SALE! - "FINANCIAL MODELING COURSE BUNDLE AT 60% OFF" Enroll Now

Perpetual Bond

Updated on April 4, 2024
Article byPrakhar Gajendrakar
Edited byPrakhar Gajendrakar
Reviewed byDheeraj Vaidya, CFA, FRM

What is a Perpetual Bond?

Perpetual bond refers to a bond without an expiration date. It is a fixed income financial instrument with no maturity date; hence it offers interest income to the instrument holder for an indefinite period. It is also known as “perps” or “consol bonds.”

Consol bonds, typically issued by governments, qualified banks, and public companiesPublic CompaniesPublicly Traded Companies, also called Publicly Listed Companies, are the Companies which list their shares on the public stock exchange allowing the trading of shares to the common public. It means that anybody can sell or buy these companies’ shares from the open market.read more, first appeared in Britain. The Beinecke Rare Book & Manuscript Library at Yale University holds a perp issued by the Dutch water authority Stichtse Rijnlanden in the 17th century and still receives interest incomeInterest IncomeInterest Income is the amount of revenue generated by interest-yielding investments like certificates of deposit, savings accounts, or other investments & it is reported in the Company’s income statement. read more and serves as one of the oldest examples.

Key Takeaways

  • Perpetual bond refers to the bonds with no maturity date. They are also known as “perps” or “consol bonds.”
  • They are fixed-income securities that deliver a perpetual flow of interest income to their holders. Also, the issuers usually do not repay the principal, and it is legally acceptable.
  • It possesses the features of both equity and debt instrument. For example, there is no stock dilution hence resembling the debt financing, and no principal repayment required, similar to equity financing.
  • A perp issued by the Dutch water authority Stichtse Rijnlanden in the 17th century is one of the oldest examples.

Fixed Income Course (5+ Hours Video Series)

–>> If you want to Master Fixed Income, then you can consider our course on “Fixed Income: Valuation, Return and Risk Measures” provides a comprehensive overview of bond valuation, return metrics, and risk management within fixed income securities. The learners will gain required skills for analyzing bond characteristics, calculating yield measures, and implementing risk mitigation strategies, equipping them for success in navigating the intricacies of bond markets.

Perpetual Bond Explained

A perpetual bond will not reach maturity or expire, and its holder can experience the interminable flow of income in a low-risk environment. It presents benefits to its issuers also. The issuers collect a lot of funds at the time of issue and do not hold the liability to repay the principal. It helps companies obtain optimal capital structuresOptimal Capital StructuresOptimum Capital Structure (OCS) is the proportion of equity and debt a company adopts to maximize its wealth and market value and minimize its cost of capital. Thus, it is calibrated to balance the company’s worth and its cost.read more, save costs, and reduce financial riskFinancial RiskFinancial risk refers to the risk of losing funds and assets with the possibility of not being able to pay off the debt taken from creditors, banks and financial institutions. A firm may face this due to incompetent business decisions and practices, eventually leading to bankruptcy.read more. In a nutshell, it provides a good choice for satisfying the financing needs of the entities.

Perpetual Bond

You are free to use this image on your website, templates, etc, Please provide us with an attribution linkHow to Provide Attribution?Article Link to be Hyperlinked
For eg:
Source: Perpetual Bond (wallstreetmojo.com)

The method of raising capital by issuing a consol bond possesses the features of both equity and debt financingEquity And Debt FinancingThe primary difference between debt and equity financing is when the company raises the capital by selling the debt instruments to the investors. In contrast, equity financing is a process in which the company presents the money by selling the company's shares to the public.read more. It is a fixed income financial instrumentFinancial InstrumentFinancial instruments are certain contracts or documents that act as financial assets such as debentures and bonds, receivables, cash deposits, bank balances, swaps, cap, futures, shares, bills of exchange, forwards, FRA or forward rate agreement, etc. to one organization and as a liability to another organization and are solely taken into use for trading purposes.read more providing its holders with periodic fixed interest income and no stock dilutionStock DilutionStock dilution is defined as a decrease in the percentage of the ownership held by the existing shareholders because of the new shares issued. Such a dilution can happen either by offering shares in exchange for funds or converting dilutive securities like stock options and convertible debt.read more resembling debt financing. At the same time, its issuers are not liable to pay back the principal at any point in the future, like in the case of equity financingEquity FinancingEquity financing is the process of the sale of an ownership interest to various investors to raise funds for business objectives. The money raised from the market does not have to be repaid, unlike debt financing which has a definite repayment schedule.read more. Furthermore, it is typically treated as an equity form of financing, thereby reducing the debt ratioDebt RatioThe debt ratio is the division of total debt liabilities to the company's total assets. It represents a company's ability to hold and be in a position to repay the debt if necessary on an urgent basis. Formula = total liabilities/total assetsread more.

There are some exceptions sometimes. For example, issuers enjoy a call option and redeem the consol bond issued. Also, if the issuer entity goes into liquidationLiquidationLiquidation is the process of winding up a business or a segment of the business by selling off its assets. The amount realized by this is used to pay off the creditors and all other liabilities of the business in a specific order.read more, they will settle the consol bond investors after all other creditorsCreditorsA creditor refers to a party involving an individual, institution, or the government that extends credit or lends goods, property, services, or money to another party known as a debtor. The credit made through a legal contract guarantees repayment within a specified period as mutually agreed upon by both parties. read more but before settling preference and equity shareholdersShareholdersA shareholder is an individual or an institution that owns one or more shares of stock in a public or a private corporation and, therefore, are the legal owners of the company. The ownership percentage depends on the number of shares they hold against the company's total shares.read more. Another finding is that sometimes a bond with a maturity period higher than 30 years is also tagged as a perp or consol bond. Furthermore, consol bondholders also face risks like interest rate riskInterest Rate RiskThe risk of an asset's value changing due to interest rate volatility is known as interest rate risk. It either makes the security non-competitive or makes it more valuable. read more and credit riskCredit RiskCredit risk is the probability of a loss owing to the borrower's failure to repay the loan or meet debt obligations. It refers to the possibility that the lender may not receive the debt's principal and an interest component, resulting in interrupted cash flow and increased cost of collection.read more.

One of the most prominent perpetual bonds in India is termed Additional Tier 1 or AT-1 bonds and is created by banks to meet their Basel III capital requirements. It illustrates a potential risk scenario. If banks run out of capital or face bankruptcyBankruptcyBankruptcy refers to the legal procedure of declaring an individual or a business as bankrupt.read more, they can write offWrite OffWrite off is the reduction in the value of the assets that were present in the books of accounts of the company on a particular period of time and are recorded as the accounting expense against the payment not received or the losses on the assets.read more the principle and not pay interest on bank AT-1 bonds. 

Formula

The current yield and present value of the perpetual bond formula are as follows:

perpetual bond formula 1
Present value of perpetual bond

Where:

  • D – Periodic coupon payment or fixed interest income
  • r – Discount rate

The concepts like the time value of moneyTime Value Of MoneyThe Time Value of Money (TVM) principle states that money received in the present is of higher worth than money received in the future because money received now can be invested and used to generate cash flows to the enterprise in the future in the form of interest or from future investment appreciation and reinvestment.read more impact the perpetual bond valuation model. Extracting the investors’ real value of interest income obtained from consol bonds depends on applying the present valuePresent ValuePresent Value (PV) is the today's value of money you expect to get from future income. It is computed as the sum of future investment returns discounted at a certain rate of return expectation.read more concept. Hence the perpetual bond price is presented as the present value of the fixed interest income or the periodic coupon payment (D), dividing D by the discount rate, r.

Example

Perpetual bond examples are always discernable from the effort of an entity or a nation to recover from debtDebtDebt is the practice of borrowing a tangible item, primarily money by an individual, business, or government, from another person, financial institution, or state.read more accumulation or other financial crises. For example, the history of issuance of consol in Britain is traced back to 1752, then again as an attempt to finance the Napoleonic and Crimean Wars, the Slavery Abolition Act, the Irish Distress Loan, and World War I. When Winston Churchill was Chancellor, he issued “4% Consols” in 1927, mainly to refinance bonds from the First World War. Also, in 1870 the US Congress authorized its issuance to consolidate the debtsConsolidate The DebtsDebt consolidation is a process which streamline several loans into a single one to receive the benefit of a lower interest rate. The reduced periodic payment leads to a reduction in liability.read more accumulated in the Civil War.

In 2020, the consol bonds were again gaining importance as an instrument to combat the issue brought by pandemic waves. For example, Spain anticipated the introduction of the EU’s issuance of consol and perceived it as an effective measure since it provides necessary financial resources.

Frequently Asked Questions (FAQs)

Are perpetual bonds a good investment?

Perps are not a high-risk investment. However, investors may face the impact of the issuer’s credit risk. Moreover, the probability of interest rate risk and liquidity risk are perceptible. For example, the issuer can refinance the issue to get a favorable interest rate, affecting investors. Also, if the issuer is going into liquidation, they can write off the principle and not pay interest.

Why would a company issue a perpetual bond?

Companies issue bonds with no maturity date to raise capital. Since it possesses no maturity date and issuers are not legally liable to pay back the principal, they are treated as equity financing. Hence, it is evident that it reduces the debt leverage or the debt portion of capital structure and possesses a non-dilutive feature.

What is the perpetual bond duration?

Perps are fixed-income bonds with no maturity date. Hence it comes with an indefinite life and no maturity value. Sometimes, a bond with a maturity date higher than 30 years is called a “consol.”

This has been a Guide to What is Perpetual Bond. Here we explain the perpetual bond formula, duration, valuation, price, and examples from Europe & India. You may also have a look at the following articles to learn more –

Reader Interactions

Leave a Reply

Your email address will not be published. Required fields are marked *