Perpetual Bonds Investment
We are in falling interest regime and the interest rates are on its way down and bank fixed deposits are no longer attractive. The other popular debt investment which is the Corporate deposits are also loosing grounds with investors because of rising default in repayment of both interest and principal. So, here is a way to optimise returns and look at other long-term fixed income products. Perpetual bonds are one such instrument in the fixed income space which come to light. These are just like any other fixed income instruments with no maturity.
How do perpetual bonds work ?
The issuer would set up terms for repayment, through a call option, say after five years or 10 years to give the investors an option to exit. The issuer of the perpetual bond incorporates the ‘step up option’. A step-up bond is a bond that pays an initial coupon rate for the first period, and then a higher coupon rate for the following periods. For example, a five-year bond paying a 4% coupon for the first two years and a 6% coupon for the final three years most likely offers a coupon below current rates at the time of inception, compensating the seller for offering higher coupons in coming periods.
These bonds are listed in the stock exchange and can be bought from the secondary market. As it is not easy to trade/buy as compared to shares, there are bond dealers who facilitate the transaction. Typically, these bonds are issued at a face value of 10 lakh per bond. A demat account is mandatory for buy/sell transaction.
Features of perpetual bonds
These bonds have a higher coupon rate or interest rate as compared to the benchmark 10-year government securities. A steady predictable income over prolonged period of time is a major attraction to own them. In a falling interest rate regime, as witnessed over the past few months, the yield from the perpetual bonds has gone up.
Though predictable and higher interest rates are attractive, one also needs to consider the credit risk and default risk of the issuer. This makes investors prefer perpetual bonds issued by public sector banks. Another point to remember is the liquidity risk, as the investor may not be able to sell the bonds, if the trading is low and the appetite for the bonds cease. Also, in a falling interest rate regime, the issuer may ‘call’ the bonds, so that a fresh issue can happen at a lower interest rate. It is important in this sense to note the ‘call’ period, before investing. The reinvestment risk and interest rate risk, which is prevalent in all debt instruments, is also applicable here, but then depending on the call option period, the timing may differ.