Governments and corporations issue debt to raise money for investing, operating and financing activities. Normally, the issuer pays interest periodically and repays the debt on the maturity date, which can range from one day hence to 30 years or more. Irredeemable, or perpetual, debt does not carry a maturity date. In theory, it will pay interest forever.
Pricing a Perpetuity
Irredeemable debt that pays a fixed interest rate is valued as a perpetuity. The security's price is equal to its present value, which is the amount of the annual payment divided by a discount factor. For example, a perpetuity might pay 3 percent annually, or 3 dollars, on its $100 face value. Therefore, its price is 3 / .03, or $100, when prevailing interest rates are about 3 percent. This is known as par value: the price equals the face value. If prevailing rates are 6 percent, the price is 3 /.06, or $50.
An issuer may attach a call option to irredeemable debt. This provides a way for the issuer to terminate the debt on a future date, known as the call date. When an issuer calls in debt, it cancels any further payments and pays a predetermined amount to the debt holder. When interest rates fall, a call feature gives the issuer the flexibility to replace relatively high-interest debt with a less-expensive issue. Investors usually price callable perpetual debt as regular debt that matures on the call date.
The most familiar example of perpetual debt is the United Kingdom's consol. First issued by the British government in 1751, consols still trade today. They pay a fixed interest rate of 2.5 percent, paid out in quarterly installments. Although consols have no maturity date, Parliament can redeem the bonds at par value at any time, but the relatively low interest rate provides little incentive for redemption. An example of a corporate U.S. perpetual bond is one issued by the West Shore Railroad Company. Its maturity date, 2351, is so distant that the debt is treated as irredeemable.
Irredeemable Loan Stock
Irredeemable convertible unsecured loan stock, or ICULS, is a hybrid of a bond and a warrant. It pays fixed amounts twice a year, but the owner can convert the security into a set number of stock shares. ICULS have an expiration date, after which they lose all value. The price of an ICULS is equal to the current stock price multiplied by the conversion ratio. For example, an ICULS that can be converted into five shares of stock currently selling for $15/share is priced at 5 x $15, or $75.
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