Perpetual Bonds
What are Perpetual Bonds?
A perpetual bond, or a perp bond, is an irredeemable bond with a perpetual fixed income. In other words, it is a bond that does not have a maturity date and cannot be redeemed. The purpose of a perpetual bond is to earn regular interest income perpetually, i.e., forever. Therefore, these bonds do not have a maturity date or a maturity value.
Similar to dividends from equity shares, perpetual bonds also provide regular income indefinitely. Therefore, perpetual bonds are sometimes considered a part of equity, and their prices are determined akin to equity shares. Moreover, perpetual bonds create a perpetual debt obligation for the issuer, only in name, as the issuer does not have to repay the amount.
Benefits of Perpetual Bonds
Perpetual bonds have various benefits for both investors and the issuer. Let us discuss its advantages for each of the mentioned parties in detail.
Benefits for Issuer
✓ Results in Cost Savings – Issuing perpetual bonds saves the issuer from the costs that he might have had to incur on reissuing bonds. It saves the costs of reissuing hybrid perpetual securities such as the prospectus, underwriting, brokerage, allotment, etc.
✓ Avoids Capital Market Risk – It is well known that capital markets are highly volatile in nature and any bond or stock within the capital markets is subject to an increase or decrease in market rates. Since perpetual bonds are not listed on the capital markets, they help avoid the risk associated with capital markets.
✓ Better Growth Opportunities – The issuers can invest in long-term projects as they do not have to repay the principal amount. This provides them with better growth opportunities.
✓ Flexibility to redeem bonds – It provides the issuer with the flexibility to redeem the bonds at their convenience.
Benefits for Issuer
✓ Results in Cost Savings – Issuing perpetual bonds saves the issuer from the costs that he might have had to incur on reissuing bonds. It saves the costs of reissuing hybrid perpetual securities such as the prospectus, underwriting, brokerage, allotment, etc.
✓ Avoids Capital Market Risk – It is well known that capital markets are highly volatile in nature and any bond or stock within the capital markets is subject to an increase or decrease in market rates. Since perpetual bonds are not listed on the capital markets, they help avoid the risk associated with capital markets.
✓ Better Growth Opportunities – The issuers can invest in long-term projects as they do not have to repay the principal amount. This provides them with better growth opportunities.
✓ Flexibility to redeem bonds – It provides the issuer with the flexibility to redeem the bonds at their convenience.
How Does a Perpetual Bond work?
The concept of perpetual bonds is simple. These are perpetual debt instruments issued by government institutions or banks for the purpose of raising capital with a fixed interest or coupon rate. Individual investors purchase these bonds to receive a fixed income perpetually, i.e., till the issuer decides to redeem the bonds. In these types of bonds, the issuer is not required to repay the principal amount. Although perpetual bonds are a risk-free investment, they still carry a credit risk for the investors. Moreover, there is a risk of the investor losing the investment value if the market interest rate becomes more than the bond’s coupon rate. To counter this risk, some issuers may offer to increase the coupon rate after a fixed number of years, depending on the market rates.
Although perpetual bonds are very different from equity in various aspects, they still resemble equity more than debt. Therefore, they are considered to be a part of equity. It is important to note that the issuer has an option to redeem the bonds after the specified time has passed. This provides the issuer with the flexibility to redeem the bonds at their convenience, making it the most sought-after option to raise finance for the issuer.
The yield of a perpetual bond on the current date can be calculated by dividing the annual coupon payment by the market price of the bond. Further, multiply the figure with 100 to express it in terms of percentage.
Here is an example –
For instance, you purchased an Rs.1000 bond at a discounted rate of Rs. 850. The annual interest income received on the bond is Rs. 80. Then, the yield will be calculated as follows –
(80/850)*100 = 9.41%
Why are Perpetual Bonds for you?
As an investor, you must be wondering why you should invest in perpetual bonds over other bonds. Here are a few reasons why perpetual bonds are your best bet –
✓ Fixed source of Income – Perpetual bonds provide you with a perpetual fixed source of income that will get credited to your bank account annually.
✓ Higher Yield – Perpetual bonds are issued by large governmental corporations or banks and therefore have a higher yield.
✓ Ease of Investment – CredAvenue provides you with a unified marketplace to explore and invest in any bond. You can compare the interest rates and the history of each bond through this platform.
FAQs
Can perpetual bonds be redeemed?
Yes, the issuer can redeem perpetual bonds when the interest rates start declining, giving the issuer a chance to refinance at a lower rate. However, they usually have a lock-in period of 5-10 years.
Are perpetual bonds equity or debt?
Although these bonds create a perpetual debt for the issuer, unlike debt, these bonds do not have to be repaid. Therefore, they are considered to be a part of equity.
How are perpetual bonds taxed in India?
The annual income from the perpetual bonds in India is included in the annual income of the investor and taxed as per the applicable slab rates.