A perpetual bond (also called a consol or “perp”) is a fixed‑income security that pays a stated coupon forever and has no maturity date. The issuer never repays principal; investors receive periodic interest payments indefinitely. Because of that perpetual cash‑flow characteristic, these instruments are often compared to stock dividends and are sometimes treated more like equity than conventional debt.
Key takeaways
– Perpetual bonds pay coupons indefinitely and have no principal repayment date.
– Their market value is driven entirely by the size of the coupon and the discount rate (required yield).
– Simple valuation uses the perpetuity formula: PV = D / r.
– They are rare because investors demand strong creditworthiness when lending money that is never repaid.
– Key risks: interest‑rate sensitivity, inflation erosion, issuer credit risk, call features, and liquidity.
How perpetual bonds work
– Coupon payments: The issuer pays a fixed interest amount (annual or periodic) forever unless they default or call the bond (if callable).
– No maturity: There is no redemption of principal at a future date.
– Callable features: Many perpetuals include call provisions that let issuers redeem the bond after a specified date, which can limit upside for investors.
– Market pricing: Since cash flows are perpetual, price is the present value of those infinite coupons; rising yields reduce price strongly.
Historical context and examples
– Consols issued by the British government are the classic example (issued in the 18th–19th centuries; some persisted for centuries).
– Perpetuals have been issued by governments (e.g., consols) and by financial institutions (often as regulatory capital).
– Issuance is uncommon because investors require high confidence in perpetual payments; sovereign or very large, stable corporations are the typical issuers.
Valuation — the perpetual bond formula
The present value (price) of a perpetual bond that pays a fixed coupon D each period is:
PV = D / r
Where:
– D = periodic coupon payment (if annual, use annual coupon; for semiannual convert appropriately)
– r = appropriate discount rate (investor’s required yield per period)
Derivation (intuitive): The present value of an infinite stream of identical payments is the payment divided by the discount rate.
Worked example
– Coupon: $10,000 per year
– Discount rate: 4% (0.04)
PV = $10,000 / 0.04 = $250,000
Sensitivity to the discount rate:
– r = 3% → PV = $10,000 / 0.03 = $333,333
– r = 4% → PV = $250,000
– r = 5% → PV = $200,000
– r = 6% → PV = $166,667
Note: Small changes in r produce large changes in price because the cash flow never stops.
Practical valuation notes
– If coupons are semiannual, convert both D and r to the same period: Dsemi = annual coupon/2; rsemi = annual yield/2, then PV = Dsemi / rsemi.
– If the bond is callable at time T for price C, expected value must incorporate the call probability and timing (discounted cash flows until call).
– For credit‑risky issuers, use a discount rate that includes credit spread over the risk‑free rate.
Risks and benefits
Benefits
– Potentially attractive income stream if coupon is high relative to prevailing yields.
– Perpetual nature can offer long‑term cash yield similar to dividends.
Risks
– Interest-rate risk: Price falls sharply if market yields rise.
– Inflation risk: Fixed coupons lose purchasing power over time.
– Credit/default risk: If issuer’s credit worsens, coupons may be cut or stopped (default).
– Call risk: Issuer may redeem when it’s advantageous for them (typically when rates fall), capping price appreciation.
– Liquidity risk: Perpetual bonds can be thinly traded, increasing transaction costs.
– Accounting/tax: Some perpetual instruments (e.g., certain bank hybrids) are treated as equity for regulatory or accounting purposes; tax treatment of coupon-like payments may differ.
How perpetual bonds are classified
– Debt vs. equity: Some perpetuals (especially bank capital instruments) are structured to count as regulatory capital or equity; others remain debt for legal/tax purposes. Always check the specific bond documentation.
– For investors, the practical implication is risk profile more similar to long‑duration bonds or preferred stock than to short‑term debt.
Practical steps for investors considering perpetual bonds
1. Identify the instrument’s terms:
– Coupon amount and payment frequency
– Callable provisions and call dates/prices
– Any step‑up clauses, convertibility, or other special features
– Legal ranking (senior, subordinated, hybrid)
2. Assess issuer creditworthiness:
– Review ratings (if available), financial statements, and earnings stability.
– Consider sovereign risk for government perpetuals or systemic risk for bank hybrids.
3. Determine an appropriate discount rate:
– Start with a benchmark risk‑free yield (e.g., government yield for matching currency and duration).
– Add a credit spread that reflects issuer risk.
– Add expected inflation premium if coupon is nominal.
4. Price the bond:
– Use PV = D / r for non‑callable perpetuals.
– For callable bonds, model cash flows to the call date and consider scenarios where the bond is and isn’t called.
5. Run sensitivity and scenario analysis:
– Show PV under several r assumptions.
– Test outcomes if the issuer calls, defaults, or inflation shifts.
6. Compare alternatives:
– Compare yield and risk to long‑dated bonds, preferred stocks, and dividend‑paying equities.
– Consider whether you prefer predictable fixed income vs. variable dividend streams.
7. Consider portfolio fit and risk limits:
– Perpetuals behave like very long‑duration securities; limit exposure if you are concerned about rising rates.
– Evaluate diversification and liquidity constraints.
8. Execution and custody:
– Trade via brokers or purchase through bond funds that specialize in perpetuals or hybrids if direct purchase is impractical.
– Verify settlement, tax treatment, and documentation.
Buying and trading
– Many perpetuals trade over‑the‑counter (OTC) or on specialized exchanges; liquidity varies widely.
– For small investors, exchange‑traded funds or mutual funds that hold long‑dated or hybrid bonds can provide easier access and diversification.
Accounting and tax considerations
– Tax treatment of coupon payments varies by jurisdiction — treat them as interest in many cases but check for instruments structured as dividends.
– For bank capital perpetuals, regulatory and accounting treatment may classify them as equity—check the prospectus and consult a tax/advisory professional.
When to prefer perpetual bonds
– You want steady income and intend to hold for a very long horizon.
– You expect yields to fall or be stable, or you want yield higher than comparable long‑dated debt.
– You accept significant interest‑rate and inflation risk.
When to avoid
– You expect rising interest rates or high future inflation.
– You need principal repayment at a known date.
– You cannot tolerate credit or liquidity risk.
Bottom line
Perpetual bonds are unique instruments that provide indefinite coupon income in exchange for no principal redemption. Their valuation is straightforward in principle (PV = coupon / discount rate), but outcomes are highly sensitive to the discount rate, call features, and issuer credit quality. They can be useful for long‑term income investors who accept elevated interest‑rate and credit risk, but careful due diligence and scenario analysis are essential.
Sources and further reading
– Investopedia, “Perpetual Bond” — https://www.investopedia.com/terms/p/perpetualbond.asp
– UK Government, “Perpetual bonds – An Investment For Life” — GOV.UK
(If you’d like, I can build an Excel template that calculates PV under multiple discount rates and call scenarios or screen recent perpetual bond issues and yields in a chosen market.)
CONTINUATION — PERPETUAL BONDS: FURTHER DETAILS, EXAMPLES, PRACTICAL STEPS, AND CONCLUSION
BRIEF RECAP
A perpetual bond (consol or “perp”) is a fixed‑income instrument with no maturity date. The issuer pays coupons forever and never repays principal. Because the cash flows are indefinite, pricing relies on perpetuity valuation formulas; because principal is never repaid and payments are indefinite, perpetuals behave more like equity (dividends) than regular debt in many respects (Investopedia; UK.gov).
DEEPER INTO VALUATION
1) Basic perpetuity (constant coupon, no growth)
– Formula: Present value (PV) = D / r
– D = periodic coupon payment (annual or adjusted for coupon frequency)
– r = discount rate (required yield for that instrument)
– Example 1 (from prior text): Coupon D = $10,000 per year.
– If r = 4% → PV = $10,000 / 0.04 = $250,000.
– Sensitivity: With r = 3%, PV = $333,333; r = 5%, PV = $200,000; r = 6%, PV = $166,667.
– Note: If market price P is known, the current yield (yield to perpetuity) = D / P.
2) Growing perpetuity (coupon increases at steady rate)
– Formula (Gordon form): PV = D1 / (r − g)
– D1 = coupon expected in next period
– g = constant growth rate of coupon (g < r required)
– Example 2: D1 = $1,000 next year, g = 2%, r = 5% → PV = $1,000 / (0.05 − 0.02) = $33,333.33.
3) Perpetuals with call provisions or step‑ups
– Many “perps” are callable by the issuer after a lock‑up. If callable, value to investor is the smaller of:
– the value if never called (perpetuity value), and
– the value implied by the issuer calling at the call price and date(s).
– Practical valuation: compute PV under both scenarios (called at earliest call date and never called) and weigh probabilities or treat the instrument as a series of conditional cash flows.
PRACTICAL EXAMPLES WITH PURCHASE PRICE/YIELD CALCS
Example 3 — Buying a perpetual in the market:
– Coupon = $8,000 yearly. Market price P = $160,000.
– Investor yield (current yield) = D / P = $8,000 / $160,000 = 5.0%.
– If investor’s required yield r = 6%, fair price should be PV = 8,000 / 0.06 = $133,333 → market price is rich relative to required yield.
Example 4 — Effect of inflation (real discounting):
– If nominal required return r_nominal = 6% and expected inflation = 2%, real discount rate r_real ≈ (1 + r_nominal)/(1 + inflation) − 1 ≈ 3.92%.
– The real PV of fixed nominal coupons is higher than when using the nominal rate, but the investor loses purchasing power—fixed coupons are worse under higher inflation expectations.
PRACTICAL STEPS FOR INVESTORS EVALUATING A PERPETUAL BOND
1) Read the offering documents (prospectus/indenture)
– Confirm coupons, frequency, call features, subordination, convertibility, covenants, tax treatment.
2) Identify cash flows
– Is coupon fixed, floating, or step‑up? Is there any contingent cancellation?
3) Determine appropriate discount rate
– Start with risk‑free rate (matching frequency) + credit spread for issuer + liquidity premium.
4) Calculate base valuation
– Use PV = D/r for fixed coupon or PV = D1/(r−g) for growing coupon.
5) Run sensitivity analysis
– Vary r and g across reasonable scenarios; show ranges of prices.
6) Model call scenarios and contingencies
– If callable, compute value under call and no‑call assumptions; consider probability of call.
7) Compare alternatives
– Compare to comparable bonds, preferred equity, dividend yields, and expected inflation.
8) Check tax implications
– Coupons may be taxed differently from qualified dividends; factor after‑tax yield.
9) Consider position sizing & liquidity
– Because some perpetuals are thinly traded, ensure you can manage trade execution and exit.
10) Monitor issuer credit and macro rates
– Changes in creditworthiness and interest rates directly affect valuation and perceived safety.
RISKS TO ASSESS
– Interest‑rate risk: price is highly sensitive to changes in market yields.
– Inflation risk: fixed coupons lose purchasing power over time.
– Credit/default risk: issuer might miss coupons or default; perpetuals can be deeply subordinated (especially hybrids).
– Call risk: issuer may call the bond when it’s advantageous to them (often when rates fall), limiting investor upside.
– Liquidity risk: some perpetuals are sparsely traded.
– Regulatory risk (for bank-issued perps/AT1s): coupons may be suspended under regulatory stress.
– Tax and legal risk: tax treatment may affect after‑tax return.
SPECIAL TYPES & MARKET USES
– Government consols: historic UK consols issued by the British Treasury are the classic example (Investopedia). Perpetuals are rare among sovereigns today.
– Perpetual preferred stock: corporate hybrids that resemble perpetual bonds but are equity for accounting.
– Additional Tier 1 (AT1) bonds: bank-issued perpetuals with loss-absorption features; higher yields but significant tail risk.
– Corporate perpetual bonds: some utilities and corporations issue perpetual subordinated debt, often callable.
HOW ISSUERS VIEW PERPETUALS
– Advantages for issuer:
– No scheduled principal repayment → less refinancing.
– May be treated as equity or quasi‑equity for regulatory or balance‑sheet purposes.
– Disadvantages for issuer:
– Coupons may be expensive (higher yield demanded).
– Market scrutiny if coupons are skipped (damage to reputation).
EXAMPLE: PRICING A PERPETUAL WITH A CALL OPTION (SIMPLE)
– Coupon D = $6,000 annually. Issuer can call at $100,000 after 5 years.
– Required yield if never called r = 6% → PV_uncalled = 6,000 / 0.06 = $100,000.
– If the instrument is likely to be called when interest rates fall, the expected value to the investor may be close to the call price (less upside). A complete valuation would:
– Discount expected coupons for the first 5 years, plus the call price at year 5 — weighted by probability of call vs. non‑call.
– Practical implication: callability caps upside; price rarely rises far above a plausible call price.
COMPARING PERPETUALS AND STOCK DIVIDENDS
– Both provide indefinite cash flows; perpetual coupons are contractual (unless issuer defaults), dividends are discretionary.
– Perpetual coupons may be subordinated; dividends reduce retained earnings but are generally more flexible.
– Consequently, perpetuals can be intermediate between debt and equity in risk/return.
PRACTICAL INVESTMENT CHECKLIST (QUICK)
– Document review → coupons, call features, subordination.
– Compute PV across discount rates; test growth scenarios.
– Assess issuer credit + likely macro scenarios.
– Consider yield vs. alternatives (bonds, preferred stock, equities).
– Plan exit strategy and position sizing.
– Consider tax/portfolio allocation implications.
CONCLUDING SUMMARY
Perpetual bonds are niche fixed‑income instruments that pay coupons forever and do not repay principal. Their valuation is straightforward when coupons are fixed: PV = D / r; when coupons grow, use the growing perpetuity formula PV = D1 / (r − g). However, real‑world complications—call provisions, step‑ups, subordination, regulatory terms (for bank perps), inflation, and credit risk—require scenario analysis and careful document review. Perpetuals can serve specific roles in portfolios (income generation, yield enhancement, exposure to issuer credit), but they demand close attention to interest‑rate sensitivity, inflation expectations, call risk, and issuer creditworthiness. Investors should run sensitivity analyses, model call/default outcomes, and compare after‑tax yields with other income alternatives before investing (Investopedia; UK.gov).
Sources
– Investopedia — “Perpetual Bond” (Zoe Hansen) — https://www.investopedia.com/terms/p/perpetualbond.asp
– UK Government — “Perpetual bonds – An Investment For Life” — (referenced above)
[[END]]
,
What Is a Perpetual Bond?
A perpetual bond (also called a consol or “perp”) is a fixed‑income security that pays a stated coupon forever and has no maturity date. The issuer never repays principal; investors receive periodic interest payments indefinitely. Because of that perpetual cash‑flow characteristic, these instruments are often compared to stock dividends and are sometimes treated more like equity than conventional debt.
Key takeaways
– Perpetual bonds pay coupons indefinitely and have no principal repayment date.
– Their market value is driven entirely by the size of the coupon and the discount rate (required yield).
– Simple valuation uses the perpetuity formula: PV = D / r.
– They are rare because investors demand strong creditworthiness when lending money that is never repaid.
– Key risks: interest‑rate sensitivity, inflation erosion, issuer credit risk, call features, and liquidity.
How perpetual bonds work
– Coupon payments: The issuer pays a fixed interest amount (annual or periodic) forever unless they default or call the bond (if callable).
– No maturity: There is no redemption of principal at a future date.
– Callable features: Many perpetuals include call provisions that let issuers redeem the bond after a specified date, which can limit upside for investors.
– Market pricing: Since cash flows are perpetual, price is the present value of those infinite coupons; rising yields reduce price strongly.
Historical context and examples
– Consols issued by the British government are the classic example (issued in the 18th–19th centuries; some persisted for centuries).
– Perpetuals have been issued by governments (e.g., consols) and by financial institutions (often as regulatory capital).
– Issuance is uncommon because investors require high confidence in perpetual payments; sovereign or very large, stable corporations are the typical issuers.
Valuation — the perpetual bond formula
The present value (price) of a perpetual bond that pays a fixed coupon D each period is:
PV = D / r
Where:
– D = periodic coupon payment (if annual, use annual coupon; for semiannual convert appropriately)
– r = appropriate discount rate (investor’s required yield per period)
Derivation (intuitive): The present value of an infinite stream of identical payments is the payment divided by the discount rate.
Worked example
– Coupon: $10,000 per year
– Discount rate: 4% (0.04)
PV = $10,000 / 0.04 = $250,000
Sensitivity to the discount rate:
– r = 3% → PV = $10,000 / 0.03 = $333,333
– r = 4% → PV = $250,000
– r = 5% → PV = $200,000
– r = 6% → PV = $166,667
Note: Small changes in r produce large changes in price because the cash flow never stops.
Practical valuation notes
– If coupons are semiannual, convert both D and r to the same period: Dsemi = annual coupon/2; rsemi = annual yield/2, then PV = Dsemi / rsemi.
– If the bond is callable at time T for price C, expected value must incorporate the call probability and timing (discounted cash flows until call).
– For credit‑risky issuers, use a discount rate that includes credit spread over the risk‑free rate.
Risks and benefits
Benefits
– Potentially attractive income stream if coupon is high relative to prevailing yields.
– Perpetual nature can offer long‑term cash yield similar to dividends.
Risks
– Interest-rate risk: Price falls sharply if market yields rise.
– Inflation risk: Fixed coupons lose purchasing power over time.
– Credit/default risk: If issuer’s credit worsens, coupons may be cut or stopped (default).
– Call risk: Issuer may redeem when it’s advantageous for them (typically when rates fall), capping price appreciation.
– Liquidity risk: Perpetual bonds can be thinly traded, increasing transaction costs.
– Accounting/tax: Some perpetual instruments (e.g., certain bank hybrids) are treated as equity for regulatory or accounting purposes; tax treatment of coupon-like payments may differ.
How perpetual bonds are classified
– Debt vs. equity: Some perpetuals (especially bank capital instruments) are structured to count as regulatory capital or equity; others remain debt for legal/tax purposes. Always check the specific bond documentation.
– For investors, the practical implication is risk profile more similar to long‑duration bonds or preferred stock than to short‑term debt.
Practical steps for investors considering perpetual bonds
1. Identify the instrument’s terms:
– Coupon amount and payment frequency
– Callable provisions and call dates/prices
– Any step‑up clauses, convertibility, or other special features
– Legal ranking (senior, subordinated, hybrid)
2. Assess issuer creditworthiness:
– Review ratings (if available), financial statements, and earnings stability.
– Consider sovereign risk for government perpetuals or systemic risk for bank hybrids.
3. Determine an appropriate discount rate:
– Start with a benchmark risk‑free yield (e.g., government yield for matching currency and duration).
– Add a credit spread that reflects issuer risk.
– Add expected inflation premium if coupon is nominal.
4. Price the bond:
– Use PV = D / r for non‑callable perpetuals.
– For callable bonds, model cash flows to the call date and consider scenarios where the bond is and isn’t called.
5. Run sensitivity and scenario analysis:
– Show PV under several r assumptions.
– Test outcomes if the issuer calls, defaults, or inflation shifts.
6. Compare alternatives:
– Compare yield and risk to long‑dated bonds, preferred stocks, and dividend‑paying equities.
– Consider whether you prefer predictable fixed income vs. variable dividend streams.
7. Consider portfolio fit and risk limits:
– Perpetuals behave like very long‑duration securities; limit exposure if you are concerned about rising rates.
– Evaluate diversification and liquidity constraints.
8. Execution and custody:
– Trade via brokers or purchase through bond funds that specialize in perpetuals or hybrids if direct purchase is impractical.
– Verify settlement, tax treatment, and documentation.
Buying and trading
– Many perpetuals trade over‑the‑counter (OTC) or on specialized exchanges; liquidity varies widely.
– For small investors, exchange‑traded funds or mutual funds that hold long‑dated or hybrid bonds can provide easier access and diversification.
Accounting and tax considerations
– Tax treatment of coupon payments varies by jurisdiction — treat them as interest in many cases but check for instruments structured as dividends.
– For bank capital perpetuals, regulatory and accounting treatment may classify them as equity—check the prospectus and consult a tax/advisory professional.
When to prefer perpetual bonds
– You want steady income and intend to hold for a very long horizon.
– You expect yields to fall or be stable, or you want yield higher than comparable long‑dated debt.
– You accept significant interest‑rate and inflation risk.
When to avoid
– You expect rising interest rates or high future inflation.
– You need principal repayment at a known date.
– You cannot tolerate credit or liquidity risk.
Bottom line
Perpetual bonds are unique instruments that provide indefinite coupon income in exchange for no principal redemption. Their valuation is straightforward in principle (PV = coupon / discount rate), but outcomes are highly sensitive to the discount rate, call features, and issuer credit quality. They can be useful for long‑term income investors who accept elevated interest‑rate and credit risk, but careful due diligence and scenario analysis are essential.
Sources and further reading
– Investopedia, “Perpetual Bond” — https://www.investopedia.com/terms/p/perpetualbond.asp
– UK Government, “Perpetual bonds – An Investment For Life” — GOV.UK
(If the business’d like, I can build an Excel template that calculates PV under multiple discount rates and call scenarios or screen recent perpetual bond issues and yields in a chosen market.)
CONTINUATION — PERPETUAL BONDS: FURTHER DETAILS, EXAMPLES, PRACTICAL STEPS, AND CONCLUSION
BRIEF RECAP
A perpetual bond (consol or “perp”) is a fixed‑income instrument with no maturity date. The issuer pays coupons forever and never repays principal. Because the cash flows are indefinite, pricing relies on perpetuity valuation formulas; because principal is never repaid and payments are indefinite, perpetuals behave more like equity (dividends) than regular debt in many respects (Investopedia; UK.gov).
DEEPER INTO VALUATION
1) Basic perpetuity (constant coupon, no growth)
– Formula: Present value (PV) = D / r
– D = periodic coupon payment (annual or adjusted for coupon frequency)
– r = discount rate (required yield for that instrument)
– Example 1 (from prior text): Coupon D = $10,000 per year.
– If r = 4% → PV = $10,000 / 0.04 = $250,000.
– Sensitivity: With r = 3%, PV = $333,333; r = 5%, PV = $200,000; r = 6%, PV = $166,667.
– Note: If market price P is known, the current yield (yield to perpetuity) = D / P.
2) Growing perpetuity (coupon increases at steady rate)
– Formula (Gordon form): PV = D1 / (r − g)
– D1 = coupon expected in next period
– g = constant growth rate of coupon (g < r required)
– Example 2: D1 = $1,000 next year, g = 2%, r = 5% → PV = $1,000 / (0.05 − 0.02) = $33,333.33.
3) Perpetuals with call provisions or step‑ups
– Many “perps” are callable by the issuer after a lock‑up. If callable, value to investor is the smaller of:
– the value if never called (perpetuity value), and
– the value implied by the issuer calling at the call price and date(s).
– Practical valuation: compute PV under both scenarios (called at earliest call date and never called) and weigh probabilities or treat the instrument as a series of conditional cash flows.
PRACTICAL EXAMPLES WITH PURCHASE PRICE/YIELD CALCS
Example 3 — Buying a perpetual in the market:
– Coupon = $8,000 yearly. Market price P = $160,000.
– Investor yield (current yield) = D / P = $8,000 / $160,000 = 5.0%.
– If investor’s required yield r = 6%, fair price should be PV = 8,000 / 0.06 = $133,333 → market price is rich relative to required yield.
Example 4 — Effect of inflation (real discounting):
– If nominal required return r_nominal = 6% and expected inflation = 2%, real discount rate r_real ≈ (1 + r_nominal)/(1 + inflation) − 1 ≈ 3.92%.
– The real PV of fixed nominal coupons is higher than when using the nominal rate, but the investor loses purchasing power—fixed coupons are worse under higher inflation expectations.
PRACTICAL STEPS FOR INVESTORS EVALUATING A PERPETUAL BOND
1) Read the offering documents (prospectus/indenture)
– Confirm coupons, frequency, call features, subordination, convertibility, covenants, tax treatment.
2) Identify cash flows
– Is coupon fixed, floating, or step‑up? Is there any contingent cancellation?
3) Determine appropriate discount rate
– Start with risk‑free rate (matching frequency) + credit spread for issuer + liquidity premium.
4) Calculate base valuation
– Use PV = D/r for fixed coupon or PV = D1/(r−g) for growing coupon.
5) Run sensitivity analysis
– Vary r and g across reasonable scenarios; show ranges of prices.
6) Model call scenarios and contingencies
– If callable, compute value under call and no‑call assumptions; consider probability of call.
7) Compare alternatives
– Compare to comparable bonds, preferred equity, dividend yields, and expected inflation.
8) Check tax implications
– Coupons may be taxed differently from qualified dividends; factor after‑tax yield.
9) Consider position sizing & liquidity
– Because some perpetuals are thinly traded, ensure you can manage trade execution and exit.
10) Monitor issuer credit and macro rates
– Changes in creditworthiness and interest rates directly affect valuation and perceived safety.
RISKS TO ASSESS
– Interest‑rate risk: price is highly sensitive to changes in market yields.
– Inflation risk: fixed coupons lose purchasing power over time.
– Credit/default risk: issuer might miss coupons or default; perpetuals can be deeply subordinated (especially hybrids).
– Call risk: issuer may call the bond when it’s advantageous to them (often when rates fall), limiting investor upside.
– Liquidity risk: some perpetuals are sparsely traded.
– Regulatory risk (for bank-issued perps/AT1s): coupons may be suspended under regulatory stress.
– Tax and legal risk: tax treatment may affect after‑tax return.
SPECIAL TYPES & MARKET USES
– Government consols: historic UK consols issued by the British Treasury are the classic example (Investopedia). Perpetuals are rare among sovereigns today.
– Perpetual preferred stock: corporate hybrids that resemble perpetual bonds but are equity for accounting.
– Additional Tier 1 (AT1) bonds: bank-issued perpetuals with loss-absorption features; higher yields but significant tail risk.
– Corporate perpetual bonds: some utilities and corporations issue perpetual subordinated debt, often callable.
HOW ISSUERS VIEW PERPETUALS
– Advantages for issuer:
– No scheduled principal repayment → less refinancing.
– May be treated as equity or quasi‑equity for regulatory or balance‑sheet purposes.
– Disadvantages for issuer:
– Coupons may be expensive (higher yield demanded).
– Market scrutiny if coupons are skipped (damage to reputation).
EXAMPLE: PRICING A PERPETUAL WITH A CALL OPTION (SIMPLE)
– Coupon D = $6,000 annually. Issuer can call at $100,000 after 5 years.
– Required yield if never called r = 6% → PV_uncalled = 6,000 / 0.06 = $100,000.
– If the instrument is likely to be called when interest rates fall, the expected value to the investor may be close to the call price (less upside). A complete valuation would:
– Discount expected coupons for the first 5 years, plus the call price at year 5 — weighted by probability of call vs. non‑call.
– Practical implication: callability caps upside; price rarely rises far above a plausible call price.
COMPARING PERPETUALS AND STOCK DIVIDENDS
– Both provide indefinite cash flows; perpetual coupons are contractual (unless issuer defaults), dividends are discretionary.
– Perpetual coupons may be subordinated; dividends reduce retained earnings but are generally more flexible.
– Consequently, perpetuals can be intermediate between debt and equity in risk/return.
PRACTICAL INVESTMENT CHECKLIST (QUICK)
– Document review → coupons, call features, subordination.
– Compute PV across discount rates; test growth scenarios.
– Assess issuer credit + likely macro scenarios.
– Consider yield vs. alternatives (bonds, preferred stock, equities).
– Plan exit strategy and position sizing.
– Consider tax/portfolio allocation implications.
CONCLUDING SUMMARY
Perpetual bonds are niche fixed‑income instruments that pay coupons forever and do not repay principal. Their valuation is straightforward when coupons are fixed: PV = D / r; when coupons grow, use the growing perpetuity formula PV = D1 / (r − g). However, real‑world complications—call provisions, step‑ups, subordination, regulatory terms (for bank perps), inflation, and credit risk—require scenario analysis and careful document review. Perpetuals can serve specific roles in portfolios (income generation, yield enhancement, exposure to issuer credit), but they demand close attention to interest‑rate sensitivity, inflation expectations, call risk, and issuer creditworthiness. Investors should run sensitivity analyses, model call/default outcomes, and compare after‑tax yields with other income alternatives before investing (Investopedia; UK.gov).
Sources
– Investopedia — “Perpetual Bond” (Zoe Hansen) — https://www.investopedia.com/terms/p/perpetualbond.asp
– UK Government — “Perpetual bonds – An Investment For Life” — (referenced above)
[[END]]