Question

Governments (monarchies) of the past issued perpetual bonds as a way to finance wars and other needs. Explain the benefits and costs of issuing such perpetual bonds. Who benefits if the perpetual bond is callable?

Answer 1

The prime advantages to the issuer by issuing such a bond are as follows:

1. For issuers, such bond issues save refinancing or issuing costs in the long run.
2. It avoids risks associated with the capital markets. All the times are not the same. It is possible that in the future when the need arises, the market scenario may not allow acquiring finances. Or the cost of fund acquisition could be higher i.e. both interest rates as well as issuing costs.
3. Bigger and time-bound project opportunities can be grabbed when funds are on hands.
4. Bonds with Callable features have an additional advantage of redeeming the bonds in favorable economic and interest rate scenarios.

Some of the main disadvantages of issuing such bonds are as follows:

1. The biggest disadvantage of these bonds is that the issuer has no choice but to keep the money with it and pay interest forever whether it needs it or not.
2. The interest rate scenario changes with time. For all other sorts of funds, an issuer would prefer to repay in declining interest rate scenario and acquire fresh funds at lower rates and vice versa. But, in the case of these bonds, the issuer has to bear with a less optimized capital structure.

The co. benefits whenever the perpetual bond is callable as when the market interest rate is lower than the coupon rate, they would call the bond and raise the same amount of fund at a lower rate. Hence benefitting the company.