Perpetual bonds are a special type of bond that never mature. Unlike traditional bonds, where the issuer repays the principal on a set date, a perpetual bond pays interest (coupons) indefinitely, without ever repaying the original loan.
So, how do these bonds work? What are their benefits and risks? Let’s break it down.
How Does a Perpetual Bond Work?
A perpetual bond is a form of debt issued by governments, corporations, or financial institutions. The issuer commits to paying interest to investors regularly but is not obliged to repay the principal—unless they decide to call the bond early (a call option).
For investors, the main attraction is a steady income stream, often at a higher interest rate than regular bonds, reflecting the extra risk involved.
Key Features of Perpetual Bonds
- No Maturity Date: Investors don’t get their principal back at a fixed time.
- Higher Coupon Payments: To compensate for no principal repayment, coupons tend to be more generous.
- Call Option: Most perpetual bonds can be redeemed by the issuer after a certain date.
- Fixed or Floating Coupons: Initial payments are usually fixed but may switch to variable rates tied to benchmarks like Euribor.
Risks of Perpetual Bonds
While perpetual bonds can offer attractive yields, they come with several risks:
1. Liquidity Risk
These bonds are relatively rare and can be hard to sell on the secondary market, which can be a problem if you need cash quickly.
2. Interest Rate Risk
If interest rates rise, the market value of perpetual bonds tends to fall, making resale less favorable.
3. Issuer Default Risk
In case of bankruptcy, holders of perpetual bonds are often paid after other creditors, increasing the chance of losses.
Historical Examples of Perpetual Bonds
Perpetual bonds have been around for centuries. Notable examples include:
- France (1825): Issued a 3% perpetual annuity to compensate exiles from the French Revolution. It remained outstanding until 1987 when the government finally redeemed it.
- Netherlands (1648): One of the oldest known perpetual bonds was issued by Hoogheemraadschap Lekdijk Bovendams, with some coupons still being paid today!
Conclusion: Should You Invest in Perpetual Bonds?
Perpetual bonds can appeal to investors looking for regular passive income with higher yields than traditional bonds. However, they carry significant risks related to coupon payments, liquidity, and the issuer’s financial health.
Before investing, it’s crucial to carefully review the bond’s terms—especially any call provisions, the level of subordination, and the issuer’s creditworthiness.
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