Perpetual bonds are one of the most interesting types of bonds available on the market. Simply put, these are bonds with no maturity date. But what are perpetual bonds in India? Read on to know more.
What are Perpetual Bonds in India?
Perpetual bonds are fixed-income securities with no maturity date that provide an endless payment of interest. This means they can technically exist forever.
Hence, the name “perpetual”, which signifies the endless nature of their lifespan.
Often, these bonds are issued by financial institutions like banks, offering them an effective way to raise long-term capital.
Issuers of these bonds commit to paying interest forever, creating a steady source of passive income for investors.
The blend of perpetual income and relative safety makes them popular for those who want risk-balanced returns for their portfolios.
Companies and other institutions issue perpetual bonds because of the absence of a repayment obligation of the principal amount. As a result, these bonds are an efficient tool to raise long-term capital.
An added feature of these bonds is the inclusion of a call option. This feature allows the issuer of a bond to redeem or “call back” the bond before its scheduled maturity date, thereby retiring the bond.
Verse: A call option gives the issuer the right, not the obligation, to buy back the bond from bondholders at a predetermined price, known as the call price, before the bond’s maturity.
Perpetual Bonds vs. Other Bonds
At this point, you must be curious to know how perpetual bonds differ from regular bonds that have an end date. That’s why we’ve curated the differences of perpetual bonds versus others.
Perpetual bonds have no maturity date and can, on paper, last forever.
Other bonds like corporate bonds and government bonds have a fixed maturity period, after which the bond is redeemed.
While nothing lasts forever, perpetual bonds are often retired when the issuer exercises the call option (if there’s one). Regular bonds may also have a call option and a maturity date.
2. Interest Payments
The issuer pays interest or coupon rates on perpetual bonds indefinitely.
For other bonds, the issuer pays interest only until the maturity date.
3. Redemption Mechanism
With perpetual bonds, the issuer is not obliged to return the principal amount.
In the case of other bonds, the issuer returns the principal amount at maturity.
4. Risk and Return
Perpetual bonds often carry a higher risk due to their indefinite duration but usually provide higher returns to offset this risk.
Other bonds typically offer lower risk and returns, as the issuer repays the principal at a predetermined maturity date.
Think of who might actually require endless capital. If you thought about financial institutions, then you’re correct.
They’re the ones who are more likely to issue perpetual bonds to meet regulatory or other capital requirements.
Regular bonds are issued by financial institutions and others like the government, corporates, and more.
How to Buy Perpetual Bonds in India?
Perpetual bonds are an attractive investment tool in India due to their perpetual income generation and relatively safe nature.
Here are the steps you must follow to learn how to buy perpetual bonds in India:
1. Identify a Broker
To start the purchasing process, it is crucial to choose a registered stockbroker who offers the option to invest in perpetual bonds.
2. Open a Trading Account
Once you’ve selected your broker, you will need to complete the Know Your Customer (KYC) process and open a trading account.
3. Conduct Research
The next stage involves conducting in-depth research to find suitable perpetual bond options available in the market.
This decision-making process should consider various aspects, including coupon rates, risk levels, and credit ratings.
4. Place Orders
After your trading account is activated, you’re ready to place the order.
Your order will be sent to the exchange for fulfilment and once that’s done, the bonds will be credited to your demat account.
You can also buy or sell perpetual bonds through the RBI Retail Direct portal.
Where to Buy Perpetual Bonds in India?
In India, there are two main avenues for buying perpetual bonds: the primary market and the secondary market.
1. Primary Market
The primary market or the issue market is where investors can apply to purchase bonds directly from the issuer.
This essentially means you’ll have the option to apply for Bond IPOs (Initial Public Offerings), because companies go public with their bonds in the primary market.
After analyzing your bid based on the terms and conditions, the issuer allocates the bonds.
Alternatively, you can secure bonds via a private placement. In this scenario, the issuer offers the bonds directly to a select group of institutional investors.
2. Secondary Market
The secondary market or the after-issue market provides an alternative platform to purchase perpetual bonds.
In fact, you’ll most likely know this market in greater detail. It is a place where investors buy bonds from others instead of the issuer.
The process is more straightforward, as there’s no application process.
Once the settlement concludes, the purchased bonds are directly credited to your demat account.
Pros of Investing in Perpetual Bonds
Like any other investment, these bonds have their advantages and disadvantages shown below.
1. Passive Income (Forever)
Perpetual bonds provide a consistent income stream through regular interest payments.
2. No Maturity Date
These bonds have no maturity date, meaning the issuer pays the interest indefinitely.
3. Flexibility for Issuers
They come with a call option, allowing the issuer to pay back the principal after a certain period if it benefits them.
Perpetual bonds differ greatly from regular bonds and thus, add a degree of diversification to a bond portfolio. Think of factors like indefinite maturity, issuer credit rating, and others.
Cons of Investing in Perpetual Bonds
1. Higher Risk
The indefinite term of these bonds means that they carry a higher risk compared to traditional bonds.
2. No Principal Repayment
Unless the issuer decides to exercise the call option, the principal amount is not repaid.
3. Market Volatility
The price of perpetual bonds is more sensitive to changes in interest rates, leading to potential capital losses.
4. Call Option
While perpetual bonds have no fixed maturity, they usually include provisions that allow the issuer to redeem or call the bonds under specific circumstances.
Impact of Interest Rates on Perpetual Bonds
The unique features of perpetual bonds do not imply that they’re immune to interest rate risk.
Much like any other bonds, a perpetual bond’s value rises or falls based on prevailing interest rates.
If the interest rate drops below the bond’s coupon rate, the perpetual bond will be attractive to investors.
On the other hand, interest rates that rise above a perpetual bond’s coupon rate will make them less attractive.
Add the competitive nature of the market into the mix and you’ll have scenarios where new bonds overtake old bonds.
For example, newly issued bonds in the market that offer higher coupon rates to battle rising interest rates would make existing perpetual bonds with lower coupon rates less attractive.
A call option would ensure that the issuer retires the bond without much damage. But if there’s no call option, then the scenarios discussed above will be all the more applicable.
Finally, rising interest rates can impact the issuer on a company level because the cost of borrowing would be high.
As a result, their credit rating may take a hit and deplete the value of the perpetual bonds already issued or to be issued.
The interplay of endless income potential, relative safety, and the call option make perpetual bonds a unique, attractive asset in the Indian financial market.
While perpetual bonds offer a potentially attractive source of ongoing income, they come with their own set of risks and considerations.
Investors must take these risks into account before choosing and investing in perpetual bonds. As always, understanding the instrument and aligning it with your financial goals is key.