Bonds are debt instruments that governments and companies use to raise finance. They can use this finance according to their needs. The people who pay for it become the lenders. After a specific period, the borrower entity must repay the amount to the people from whom they have taken the loan. It is how usual bonds work. However, there are some variations to this structure of bonds.
What is a Perpetual Bond?
A perpetual bond is a type of bond issued by entities that does not have a maturity date. Essentially, these bonds run forever. Therefore, the borrower has to pay the lender an interest payment forever. In essence, perpetual bonds are equity rather than debt. It is because they run throughout the company’s lifetime and have some other characteristics similar to equity.
How do Perpetual Bonds work?
Primarily, perpetual bonds are debt instruments. Through the issuance of these bonds, companies receive finance for their activities. However, in essence, these are not debt obligations. The issuer of the bond does not have to repay the lender at any time in the future. The bond runs for perpetuity as it does not come with a maturity date or a promise of repayment.
The bond issuer has to pay the borrower interest payments on the bond. Perpetual bondholders get interest payments throughout their ownership regardless of whether the entity makes a profit or loss. However, because the borrowing entity does not have to repay the loaned amount, it also gives perpetual bonds equity characteristics.
For investors or lenders, perpetual bonds are similar to dividend-paying stocks. However, dividend-paying stocks do not come with fixed returns. On the other hand, perpetual bonds do. Perpetual bonds also provide investors with a steady income. But unlike dividend-paying stocks, they cannot earn more when the company makes higher profits. Similarly, these bonds don’t come with any voting rights.
Perpetual bonds share a close relationship with annuities. Annuities are investments that provide an unending stream of income to investors. In the same way, perpetual bonds come with interest payments to investors for an indefinite period of time.
What are the advantages of Perpetual Bonds?
Perpetual bonds have some advantages for investors. They come with a steady source of income, which some investors prefer. Similarly, the interest payments on these bonds are predictable and come after a predetermined amount of time. For investors that like to have assurance about their income, perpetual bonds are a great option.
Some perpetual bonds also come with increasing interest rates. Usually, the issuer sets the bond’s interest rate to increase at predetermined points in the future. It is great for when the interest rates in the market increase, so borrowers get compensated for their investments.
What are the disadvantages of Perpetual Bonds?
Perpetual bonds also come with some disadvantages. Firstly, investors can receive better returns on equity investments compared to these bonds. For companies that have significant profitability increases, investors earn lower returns on perpetual bonds.
Perpetual bonds also come with credit risk. If the entity that issues these bonds liquidates, investors can lose all their investment. Similarly, when the interest rates in the market rise, perpetual bonds will not provide the best returns.
Conclusion
Perpetual bonds are bonds that run forever. Issuers have to pay interest payments on these bonds but don’t have to return the borrowed amount. Perpetual bonds can have several advantages due to the fixed income that investors get.
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