Perpetual Bonds

Perpetual Bonds are a type of fixed-income security that, unlike regular bonds, doesn’t have a maturity date. That means the issuer never has to repay the principal unless they choose to. Instead, the bond pays interest to the investor indefinitely, usually at a fixed rate.

What is a Perpetual Bond?

A Perpetual Bond is like a never-ending loan from the investor to the issuer. The issuer gets to use the money for as long as they want, and in return, they keep paying interest. These are often used by banks and financial institutions to strengthen their capital base since regulators may treat them as part of Tier 1 capital.

From an investor’s point of view, perpetual bonds can offer attractive returns, but they also come with risks such as interest rate changes, credit risk, and the fact that you might never get your principal back unless the issuer decides to “call” the bond (i.e., buy it back).

Features of Perpetual Bonds

• No Maturity Date: These bonds have no end date and can theoretically last forever.
• Fixed Interest Payments: Interest (coupon) is paid regularly, usually semi-annually or annually.
• Higher Coupon Rate: They usually offer higher interest rates compared to normal bonds.
• Callable Option: Issuers may redeem (call) the bond after a certain period (e.g., 5 or 10 years).
• Risk Level: Investors may never get back their principal unless the issuer calls the bond.
• Price Sensitivity: Their price is highly sensitive to interest rate changes due to infinite duration.
• Used by Banks: Often issued to meet regulatory capital requirements.

How does a Perpetual Bond work?

Let’s understand the working of perpetual bonds using the example of Wonga, an avid investor.

Wonga invests ₹100,000 in a perpetual bond issued by a large bank offering an 8% coupon rate. Every year, he receives ₹8,000 (8% of ₹100,000). This continues forever as long as the bank remains financially sound.

Since the bond has no maturity, Wonga will never automatically receive his principal back. After 5 years, the bank says: “Wonga, here’s your ₹100,000 back. We’re closing this deal.” This is an example of the call option, where the bank chooses to redeem the bond on the predetermined call date.

Wonga understands the risks: the bank may skip interest payments if it faces trouble, and in the event of a failure, Wonga is paid last. He may even lose his ₹100,000.

In summary, Wonga gives ₹100,000 and receives ₹8,000 every year forever (or until the bank calls the bond), but the return of principal is not guaranteed unless the issuer redeems it.

Why do issuers issue Perpetual Bonds?

Based on Wonga’s example, you might wonder why banks or companies issue perpetual bonds. Here are the main reasons:

• To Raise Long-Term Capital: Perpetual bonds provide funds without a fixed repayment date, allowing issuers to use the money for a very long time.
• To Strengthen Capital Structure: Banks often use these bonds as Tier 1 capital to meet regulatory requirements.
• Lower Immediate Pressure: With no maturity date, issuers do not face large repayment obligations—only periodic interest payments.
• Flexibility: Issuers include a call option allowing them to redeem the bond if interest rates fall or they have surplus funds.

How to calculate the yield of a Perpetual Bond?

The yield of a perpetual bond is the return an investor earns based on the annual coupon and the current market price.

Formula:

Yield = (Annual Coupon Payment / Current Market Price) × 100%

Example:

• Face Value: ₹100,000
• Coupon Rate: 8%
• Annual Coupon Payment: ₹8,000
• Current Market Price: ₹95,000

Yield = (8,000 / 95,000) × 100% = 8.42%

Since Wonga buys the bond at ₹95,000, his yield becomes 8.42%—slightly higher than the coupon rate because he purchased the bond at a discount.

Examples of Perpetual Bonds

One example is the 9.55% Tata Capital Limited Perpetual Bond with a call date of 2nd March 2031. This bond has no fixed maturity, so Tata Capital is not required to repay the principal unless they choose to.

The bond includes a call option that allows Tata Capital to buy back the bond on or after 2nd March 2031. Until then, investors receive a fixed interest rate of 9.55% annually. If the issuer calls the bond, investors get their principal back. If not, the bond continues to pay interest indefinitely, offering steady income but with uncertainty about when, or if, the principal will be returned.