Perpetual Debt

Perpetual Debt Fixed Income Financial Instruments Interest Payments LIBOR
A type of debt instrument for which the issuer typically has neither the right nor the obligation to repay the principal amount of the debt. Interest is usually paid at a constant rate or at a fixed margin over a benchmark, such as the London Inter Bank Offered Rate (LIBOR).
On this page

What is Perpetual Debt?

Perpetual debt, also known as a perpetual bond or consol, is a type of fixed-income security with no maturity date. This means that the issuer is not required to repay the principal to the bondholders. Instead, they are obligated to pay interest indefinitely. These interest payments can be constant or determined by a fixed margin over a benchmark rate, like the London Inter Bank Offered Rate (LIBOR).

Key Characteristics of Perpetual Debt:

  1. No Maturity Date: Perpetual bonds do not have a set date for principal repayment.
  2. Fixed or Variable Interest: Interest is paid either at a constant rate or as a margin over a benchmark rate.
  3. Callable Option: Some perpetual bonds can be called by the issuer after a certain period, allowing for the possibility of repayment before perpetuity.
  4. Risk and Reward: Investors bear the risk of not receiving their principal back but can benefit from perpetual interest income.

Examples of Perpetual Debt:

  1. Corporate Perpetual Bonds: Large corporations sometimes issue perpetual bonds to finance long-term projects or strengthen their capital structure. For instance, in 2019, AT&T issued a series of perpetual preferred securities.
  2. Government Consols: Historically, governments have issued consols, such as British consols first issued in the 18th century, which were redeemable at the government’s discretion but typically paid interest perpetually.

Frequently Asked Questions (FAQs)

1. Why would an investor buy perpetual debt?

Answer: Investors seek perpetual debt for stable income and may perceive them as less risky compared to equities. They are suitable for those aiming for long-term, reliable interest payments.

2. What are the risks associated with perpetual debt?

Answer: The key risks include interest rate risk, where rising rates can make the fixed payments less attractive, and call risk, where the issuer might repay the bond early if it’s callable, typically when interest rates decline.

3. Can perpetual bonds be traded?

Answer: Yes, perpetual bonds can be traded on secondary markets, offering liquidity to investors who may wish to sell them before perpetuity.

4. How is interest income from perpetual debt taxed?

Answer: Interest income is typically taxable as ordinary income, though specific tax treatment can vary based on jurisdiction and type of issuer.

5. Can perpetual debt be converted to equity?

Answer: Some perpetual bonds come with conversion options, allowing bondholders to convert their holdings into equity, typically shares of the issuing company.

  1. Principal: The amount of money borrowed or invested, excluding interest and other financial charges.
  2. Interest: The cost paid for borrowing money, typically expressed as an annual percentage of the principal.
  3. London Inter Bank Offered Rate (LIBOR): A benchmark rate that some of the world’s leading banks charge each other for short-term loans. LIBOR is often used as a benchmark for other interest rates.

Online References

Suggested Books for Further Studies

  • “Investments” by Zvi Bodie, Alex Kane, and Alan J. Marcus
  • “Bond Markets, Analysis, and Strategies” by Frank J. Fabozzi
  • “Fixed Income Securities: Tools for Today’s Markets” by Bruce Tuckman and Angel Serrat

Accounting Basics: “Perpetual Debt” Fundamentals Quiz

### What is a defining feature of perpetual debt? - [ ] Repayment schedule aligned with a 10-year term. - [x] No maturity date for the principal repayment. - [ ] Interest compounding quarterly. - [ ] Issued only by governmental bodies. > **Explanation:** Perpetual debt is characterized by having no maturity date, meaning the principal is not meant to be repaid, ever. ### Why might a corporation issue perpetual bonds? - [x] To finance long-term projects without the obligation to repay principal. - [ ] To raise short-term capital. - [ ] To reduce their current asset values. - [ ] To hedge against currency risk. > **Explanation:** Corporations may issue perpetual bonds to finance long-term investments without the obligation of repaying the principal amount. ### What benchmark rate is commonly used to determine variable interest payments on perpetual debt? - [ ] Prime Rate - [ ] Federal Funds Rate - [x] London Inter Bank Offered Rate (LIBOR) - [ ] Discount Rate > **Explanation:** LIBOR is commonly used as a benchmark to set variable interest payments for perpetual bonds. ### Which type of security is characterized by no redemption by the issuer? - [ ] Adjustable-rate mortgage - [ ] Term bond - [x] Perpetual bond - [ ] Convertible note > **Explanation:** Perpetual bonds do not require redemption by the issuer, distinguishing them from other fixed-income securities with set maturity dates. ### Can perpetual bonds be traded on secondary markets? - [x] Yes, they can. - [ ] No, they must be held until a future organizational dissolution. - [ ] Only if issued by governments. - [ ] Trading varies annually. > **Explanation:** Perpetual bonds can indeed be traded on secondary markets, providing liquidity options for investors. ### What risk arises if interest rates increase significantly for holders of perpetual bonds? - [ ] Credit risk - [ ] Inflation risk - [x] Interest rate risk - [ ] Currency risk > **Explanation:** Interest rate risk affects perpetual bonds negatively since fixed interest payments become less attractive when market rates rise. ### What might an issuer do if they have callable perpetual bonds and market interest rates drop? - [x] Call the bonds, repay the principal, and issue new bonds at a lower rate. - [ ] Keep paying the original interest rate. - [ ] Increase the interest rate. - [ ] Convert bonds to equity. > **Explanation:** Issuers might call bonds and reissue new debt at lower market rates if the bonds are callable and the interest rates significantly drop. ### How is interest income from perpetual bonds typically taxed? - [ ] As capital gains. - [x] As ordinary income. - [ ] It's exempt from taxes. - [ ] At a lower flat rate. > **Explanation:** Interest income from perpetual bonds is generally treated as ordinary income for tax purposes. ### Who primarily benefits from perpetual debt instruments? - [ ] Short-term traders. - [x] Long-term income-focused investors. - [ ] Those seeking quick capital gain. - [ ] Monetary policy bodies. > **Explanation:** Long-term income-focused investors benefit from the stable ongoing interest payments characteristic of perpetual debt. ### What is one reason perpetual bonds may seem riskier compared to other bonds? - [x] The principal is never repaid, leaving capital at ongoing risk. - [ ] They offer lower interest payments. - [ ] They must be held for a fixed termed period. - [ ] They have a fluctuating interest rate. > **Explanation:** Since perpetual bonds do not have a maturity date for principal repayment, the capital remains at risk indefinitely, contributing to higher perceived risk for investors.

Thank you for embarking on this journey through our comprehensive accounting lexicon and tackling our challenging sample exam quiz questions. Keep striving for excellence in your financial knowledge!

Tuesday, August 6, 2024
Perpetual Inventory System
Perpetual Audit
Asset-Backed Medium-Term Note (ABMTN) January 1, 1
Contract Rate January 1, 1
Coupon Bond January 1, 1
Debt Security January 1, 1
Gilt Strip January 1, 1
Inter Bank Offered Rate (IBOR) January 1, 1
London InterBank Offered Rate (LIBOR) January 1, 1
Repackaged Perpetual Debt January 1, 1

Accounting Terms Lexicon

Discover comprehensive accounting definitions and practical insights. Empowering students and professionals with clear and concise explanations for a better understanding of financial terms.