A perpetual bond is a quasi-equity instrument, which does not have a fixed maturity and in fact can exist perpetually with no principal repayment but only a coupon interest payment. The payment of such coupon is, however, at the discretion of the issuer who may decide to not make coupon payments in the year in which it has incurred losses or does not have enough reserves to make such payments. Banks in India pay the coupon after meeting the common equity tier I, tier II capital and total capital requirement ratios. Additionally, they have the discretion to cancel the coupon payments without the Reserve Bank of India’s (RBI) permission upon not meeting the requirements set by the regulator. This coupon rate on the perpetual bonds can be a fixed rate or a floating rate linked to an external benchmark.
Theoretically, the price of a perpetual bond is determined by dividing the coupon with the discounting rate. Perpetual bonds often have a call option attached to it, which gives the issuer a right, but not an obligation, to buy back these bonds at a certain price that is predetermined at the time of issuing the bonds. While these bonds are designated as perpetual bonds, the investors may, however, liquidate investments in perpetual bonds by selling them off in the secondary market.
In our fourth volume of financial services risk insight, we deep dive into world of perpetual bond market and what the future holds for them.
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