One of the fascinating aspects of (financial) bond is that there are many flavors of it. A bond is an I.O.U., you lend me money, I will pay you interest and at the end the loan is repaid. So why are there so many flavors of it?
I remember reading an opinion somewhere that the many flavors of bonds was cooked up by clever financiers to complicate matters and fleece the unknowing out of their money. For example, ‘convertible’ bonds are loans that can convert into shares. Which seems odd, if you want to borrow money, you issue loans; if you want to raise cash, you issue shares. Why do something in between, half and half?
Turns out these deals are usually sweetheart deals given to the owners or white knights rescuing a company. These convertibles usually have high interest rates and at the end of the day, stealthily dilutes existing shareholders’ stake as the loans converts to shares sometime in the future.
With this in mind, I saw something called a perpetual callable bond recently in the local market. 7% interest rate at a time when FD is around 3%, which is quite high. A perpetual is a type of bond which pays interest perpetually, no end date. The twist is that it is callable. So by 5th year the owner may decide to pay back the loan. Again a half and half. So what gives?
Now one of the possible reasoning is that the company may have issued the bond expecting interest rate to go up drastically. Because they want to hedge their bet, they made it callable. If interest did go up, they have in hand a cheap perpetual bond. If interest rate stays the same and go down, they can ‘call it’ and end the loan. Genius!
Of course this is just one reading of it. The next question then is always ‘is 7% worth the risk and trouble?’ That, to each his own and as always, the actual reasons maybe different from the above.