• All blog entries
    • Calculators
    • Case studies
    • Cost of living
    • CPF Are You Ready?
    • CPF Matters
    • Credit Management
    • e-Learning
    • Estate Planning
    • Events
    • Financial advisers
    • High Networth
    • Insurance
    • Investments
    • Letters to the Press
    • Magazines
    • Others
    • Retirement Planning
    • Scams
    • Surveys
    • Tragic Stories
    • Unethical sales process
    • Videos
  • Legal
  • Testimonies
    • Individual testimonies
    • Gallery
  • My Account
Hi, looking for a fee-based financial planner in Singapore? Read this article now!
  • Home
  • About
    • About Wilfred Ling
    • Why do you run your own professional financial planning practice?
  • FAQs
    • FAQs on Wilfred Ling’s Financial Services
    • FAQs on Financial Planning
    • FAQs on Investments
    • FAQs on Insurance
    • FAQs on Estate Planning
  • Services
    • Overview
    • Create a financially secure plan for your young family (package details)
    • Retirement Planning
    • Investment Portfolio Management
    • Insurance Planning
  • Fees
  • Cool Tools
  • Contact
  • Subscribe
You are here: Home / Investments / Risk of a Perpetual Bond which investors do not know or understand

Risk of a Perpetual Bond which investors do not know or understand

6, March 2012 by Wilfred Ling Leave a Comment

Last Updated on 7, April 2014

In the fixed income world, duration is defined as the percentage change in price of the bond when there is a change in one percentage change in interest rate. What is the duration of a perpetual bond?

I shall not go into differentiation equation but would demonstrate it with just a very simple example. Initially when the bond is issued, it is issued at par with a coupon (assuming annual coupon for simplicity) of C. Let's say the coupon rate is 5%. So C = $5 for par $100. Over time, the value of the bond is P = $5 / R where R is the discount rate. If R = 5%, P = $100 which is the par value. If the interest rate goes up by 100 bps (assuming paralleled shift in the yield curve), P = $5/6% = $83.33. The % change in price of the bond is 83.33/100 -1 = -16.7%. The duration is 16.7 for this case. As it can be seen that a perpetual bond is highly sensitive to interest rate.

A traditional bond will mature at par (assuming no default) and thus any previous losses due to interest increase is not relevant if held to maturity.

But for the perpetual bond, there is no maturity date. Thus, there is no definite date which the bond will mature at par. It is possible to be sitting at a lost for a very long time. But it appears that these perpetual bond is callable after X years. When it is callable, the bond issuer redeems the bond because it can reissue new bonds at a lower discount rate. This happens when the interest rate is lower than that of initially. But this is bad news for holders of these called bonds as they supposed to be sitting at a profit only to be redeemed at par. It is for this reason, the callable feature is a call option held by the bond issuer. For bond holder is effectively buying a bond with infinite maturity and writing a call option. Thus, the price of the bond is roughly given by:

P = B - c

Where B is the price of a normal bond with infinite maturity and c the value of the call option. When interest rates drop, the value of 'c' gets more valuable putting a cap on the value of P. This means, the upside to the bond is limited.

The conclusion is this: The perpetual bond has limited upside (if it is callable), extremely sensitive to interest rate risk and a bond holder could be sitting at a lost for a very long time.

Currently, interest rate in the world is at all time low with the developed countries in its expansionary monetary policy. Imagine what happens when interest rate goes up. Good luck for perpetual bond holders! Make sure you got enough fire power otherwise your retirement age could be extended perpetually!

Like this article? Subscribe to my newsletter below for more.

Get regular Tips on Financial Planning. Free subscription for 3 years. Covers all aspect of financial planning such as 'How much salary you should have?', 'How to avoid insurance that is not suitable?", 'What are the retirement planning methods?", etc

Share this:

  • Tweet
  • Print

Related

Filed Under: Investments

What do you think? Leave a comment. Cancel reply


WILFRED LING, CFA

WANT TO GET REGULAR TIPS ON FINANCIAL PLANNING?

JOIN with thousands of other subscribers in getting tips on all aspect of financial planning such as "What is the minimum salary required?", "How avoid insurance that is not suitable", etc.


WILFRED LING IN THE NEWS

Click HERE to find out more.


THE KIND OF CLIENTS I AM LOOKING FOR

NEW TO US?

Learn how you can fully benefit from this massive website: HERE

For Registered Users Only (free)

  • Webinar on 7 Real Stories To Achieve Your Financial Freedom 6/6/2023
  • Webinar on Major change in cancer treatments in your integrated shield plans 3/9/2022
  • How and what to invest now? (Webinar) 28/7/2022
  • How to identify high performing unit trusts in 3 steps (Webinar) 3/9/2021
  • Financial Planning – Christian Perspective Part 2 (Webinar) 14/8/2021

View All

For Clients Only

  • Video Message to Clients 30/12/2021
  • Exclusive client-only Investment Update Webinar by Wilfred 26/11/2021
  • JPMorgan Guide to Market Q2 2020 15/4/2020
  • JPMorgan Perspective Q2 2020 15/4/2020
  • JPMorgan Guide to Market Q1 2020 5/2/2020

View All

Recent comments

  • Dipokdas on Travel Without Financial Worries: 3 Tips to Achieve Financial Independence (Sydney)
  • Nay Nay on Is PruSelect Vantage plan a good or bad product?
  • Basil on Question on Manulife InvestReady
  • mah weng kong on Is PruSelect Vantage plan a good or bad product?
  • Rafi on Wilfred Ling’s Story, the beginning
  • ECE7 on Wilfred Ling’s Story, the beginning

To be notified of new blog post, like this facebook page

To be notified of new blog post, like this facebook page

Read articles based on different categories

Chartered Financial Analyst

CFA

Chartered Financial Consultant

ChFC

Featured Blogger

IM$avvy

© Copyright 2006-2025 Wilfred Ling

This advertisement or publication has not been reviewed by the Monetary Authority of Singapore

hollow-nasty
hollow-nasty
hollow-nasty
hollow-nasty