You can refer to bonds that never expire as "perps," which is short for "perpetual," another name. Like conventional bonds, they provide investors with periodic income in the form of coupon payments, but the bond's principal amount is not subject to a redemption date. In theory, perpetual bonds' coupon payments will be made indefinitely or "in perpetuity."

Perpetual Bonds: An Overview

A perpetual bond is a type of financial obligation. However, the issuer is not obligated to return the bond's principal if interest payments remain. Some financial experts have compared perpetuals to dividend-paying stocks. Perpetual bonds and dividend stocks may have certain similarities, but they are superficial at best.

Whereas coupon payments on perpetual bonds are set and do not fluctuate, dividend payments to stockholders tend to fluctuate over time, dependent on the firm's profitability. Furthermore, permanent bondholders do not have the same voting rights as stockholders.

Perpetuals may be analogous to annuities. An annuity is a type of investment that promises to give its owner a steady source of income for life. Similarly, investors may count on receiving coupon payments on perpetual bonds for an infinite amount of time.

Will We Ever Stop Receiving Coupon Payments?

People often question whether or not the "forever" nature of perpetuals' coupon payments is based on the issuer never redeeming the bond. After a certain time, say five years from the date of issuance, the issuer of a perpetual bond often has the right to "call" or redeem the bond. Consequently, some perpetual bond issuers do ultimately repay their obligations.

Although there is no set a date for redemption on perpetual, the issuer nevertheless reaps the benefits of this structure. Thus, the issuer has some leeway in determining when the redemption will occur. The bonds can be redeemed whenever it is most convenient financially.

Who Issues Perpetual Bonds?

Perpetual bonds are a tiny fraction of the overall bond market. Organizations like governments and financial institutions typically issue perpetual bonds. Financial institutions will often turn to the sale of bonds to raise capital; the funds they get from bondholders count as Tier 1 capital; therefore, issuing such securities is a common way.

Perpetual bonds say some economists, are a great way for cash-strapped governments to get by. However, most classical economists oppose governments issuing debt they are not obligated to repay. They also argue that a government is not a good fiscal policy to assume the contractual duty of making payments to anybody in perpetuity.

The Allure to Potential Financiers

Retirees looking to guarantee a steady income stream in their golden years often turn to perpetual bonds as a safe investment option. Furthermore, issuers usually provide higher coupon payment rates with perpetual bonds compared to equivalent ordinary bonds with a defined maturity date as compensation for investors for the "no specified redemption date" aspect of perpetual.

If you invest in perpetual bonds, you won't have to worry about replacing your maturing bonds with anything else, saving you time and energy. The issuer's credit risk is something perpetual bondholders must take into account. Similar to bonds, credit risk exposure will never go away.

Additionally, investors may be subject to interest rate risk, which is the potential for a negative return on investment should interest rates increase beyond the coupon rate of their perpetual bond. A perpetual bond issuer may include a "step-up" provision, wherein the coupon rate is increased at regular intervals to spread the interest rate risk.

How to Determine the Yield on an Indefinite Bond

The yield on a perpetual bond can be estimated as follows for potential buyers: To calculate the yield on a perpetual bond, divide the present value of all coupon payments by the bond's market price in a given year, then multiply the result by 100.

For the sake of argument, let's pretend that you paid $950 for a $1,000 perpetual bond that had previously sold for $1,000. Annual coupon payments will bring in $80 for you.

Who Should Invest In Perpetual Bonds?

Retirees looking to guarantee a steady source of income for the rest of their lives often purchase perpetual bonds. These bonds provide a higher yield since they are issued mostly by banks or government agencies. Investors should consider the tax implications, even though the rates are appealing. Said, the interest earned after deductions is the amount available for investment.

When a bond expires, investors in perpetual bonds don't have to worry about replacing it immediately, saving them time and energy. However, credit and interest rate risks are real concerns for investors. For investments with a "perpetual coupon," the value of the investment will decrease if the interest rate climbs above the coupon rate.