What is a perpetuity bond?

Question

I know it continues indefinitely, and the payment is not fixed right? It varies with the interest rate.

Can you explain exactly how it works?

Answer 1

A perpetuity bond is a bond without a maturity date, meaning that the stream of interest will continue forever, but that the principal will never be paid back. The payment can be fixed or depend on an index. In France certain companies have them issued and the interest depends on the revenues of the company or the interest rates of certain European bonds.

Answer 2

A good example of a perpetuity bond is a console bond. Consols (originally short for consolidated annuities, but can now be taken to mean consolidated stock) are a form of British government bond (gilt), dating originally from the 18th century. Consols are considered one of the rare examples of an actual perpetuity, although they may be redeemed by the issuer.

In 1752, the Chancellor of the Exchequer and Prime Minister Sir Henry Pelham converted all outstanding issues of redeemable government stock into one bond, Consolidated 3.5% Annuities, in order to reduce the coupon rate paid on the government debt.

In 1757, the coupon rate on the stock was reduced to 3%, leaving the stock as Consolidated 3% Annuities. The coupon rate remained at 3% until 1888. In 1888, the Chancellor of the Exchequer, George Joachim Goschen, converted the existing Consolidated 3% Annuities, along with Reduced 3% Annuities (issued in 1752) and New 3% Annuities (1855), into a new bond, 2¾% Consolidated Stock under the National Debt (Conversion) Act 1888 (Goschen’s Conversion). As part of the terms of the Act, the coupon rate of the stock was reduced to 2½% in 1903, and the stock given a first redemption date of 5 April 1923, after which point the stock could be redeemed at par value by Act of Parliament.

As you can see, the interest rate can stay fixed over very long time periods.