A perpetual bond, often referred to as a “consol bond” or “perp,” is a unique type of fixed income security with no maturity date. It’s frequently considered a form of equity rather than debt because it continuously pays a steady stream of interest. Although these bonds cannot be redeemed, they offer continuous interest payments indefinitely.
Key Takeaways
- Perpetual bonds, or consol bonds, have no maturity date.
- They provide a perpetual stream of interest payments despite being non-redeemable.
- Considered a form of equity due to their ongoing interest payments.
Understanding Perpetual Bonds
Perpetual bonds occupy a specialized sector within the bond market. This narrow niche comes from requiring extremely secure entities to issue such bonds, as the principal will never be repaid. Noteworthy perpetual bonds include those issued by the British Treasury for World War I and the South Sea Bubble of 1720. Some suggest that the U.S. federal government issue perpetual bonds to avoid refinancing costs associated with traditional bond maturities.
Example of a Perpetual Bond
Given their indefinite interest payments, perpetual bonds are often compared to stock dividends. These bonds are priced similarly, based on the fixed interest, or coupon payment, divided by a constant discount rate that accounts for the devaluation of money over time. Despite having no maturity date, perpetual bonds can be assigned a finite value, representing their price.
Present value = D / r
Where:
- D = periodic coupon payment of the bond
- r = discount rate applied to the bond
For instance, if a perpetual bond pays $10,000 annually and the discount rate is 4%, the present value is calculated as:
Present value = $10,000 / 0.04 = $250,000
It’s important to note that the present value is highly sensitive to the discount rate. Using our example with varying discount rates, we get:
- Present value (3%) = $10,000 / 0.03 = $333,333
- Present value (4%) = $10,000 / 0.04 = $250,000
- Present value (5%) = $10,000 / 0.05 = $200,000
- Present value (6%) = $10,000 / 0.06 = $166,667
Related Terms: Consol Bond, Fixed Income, Discount Rate, Stock Dividend, Equity.
References
- UK.gov. “Perpetual bonds - An Investment For Life”.
Get ready to put your knowledge to the test with this intriguing quiz!
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## What is another name for a perpetual bond?
- [ ] Term bond
- [ ] Balloon bond
- [x] Consol bond
- [ ] Callable bond
## What is the key characteristic of a perpetual bond?
- [ ] It matures in 30 years
- [ ] It has a balloon payment at maturity
- [x] It has no maturity date
- [ ] It is callable after 5 years
## How are interest payments on perpetual bonds typically structured?
- [x] Fixed and ongoing forever
- [ ] Increasing every year
- [ ] Decreasing annually
- [ ] Paid as a lump sum at maturity
## Which entity is most likely to issue perpetual bonds?
- [ ] Individuals
- [x] Corporations and governments
- [ ] Start-up companies
- [ ] Municipalities only
## What might be a major drawback of holding a perpetual bond?
- [ ] Fixed payment amounts decrease over time
- [ ] The interest payments expire after 10 years
- [x] The investor may never recover the principal amount
- [ ] Interest rates are adjustable monthly
## How do perpetual bonds typically respond to interest rate changes?
- [ ] They are unaffected by interest rates
- [x] Their prices are inversely related to interest rate changes
- [ ] Their coupon rates change to match interest rates
- [ ] Their demand increases regardless of interest rates
## Why might an investor choose a perpetual bond?
- [x] For steady and predictable income
- [ ] For capital gains purposes
- [ ] To recover a lump sum quickly
- [ ] Because their values are unaffected by inflation
## Which risks are associated with perpetual bonds?
- [ ] They are risk-free investments
- [ ] They are always highly liquid
- [x] Interest rate risk and inflation risk
- [ ] Guaranteed returns and zero volatility
## Which type of investor is most likely to benefit from perpetual bonds?
- [ ] Speculative day traders
- [ ] Those seeking rapid capital gains
- [ ] Young investors with a high-risk tolerance
- [x] Income-focused, long-term investors
## How is the present value of a perpetual bond typically calculated?
- [ ] By dividing the bond's face value by the coupon rate
- [ ] By calculating the future value of the bond payments
- [x] By dividing the annual coupon payment by the market interest rate
- [ ] By subtracting the bond's coupon rate from the yield curve average
