Principles of Finance: Unit 5, Perpetuity

Perpetuity. Gesundheit. Wait, that wasn’t a sneeze? Oh…then what on earth is perpetuity?

CoursesFinance Concepts
Principles of Finance
FinanceFinancial Responsibility
Personal Finance
Finance and EconomicsPrinciples of Finance
LanguageEnglish Language
Life SkillsPersonal Finance
SubjectsFinance and Economics

Transcript

00:21

preferred stocks promise of dividend payments Why Well because thie

00:26

old school version of a real perpetuity has all but

00:29

died in modern investing perpetuity sze were kind of thing

00:33

in eighteenth century england They funded royal projects like gardens

00:39

and universities and hospitals and you know sewer systems When

00:42

that was a new thing back then you know that

00:44

was a tech Well they were you know researching what

00:47

to do there remember lots of horses back then given

00:50

the complexity and volatility and global nous of the investing

00:54

world today perpetuity sze has a structured investment vehicle really

00:57

aren't so much of a thing anymore but quote forever

01:00

paying unquote dividends for preferred stocks well are so preferred

01:05

stock think back again teo that little sauce company we're

01:09

talking about the two kids already in birdie who raised

01:12

venture capital money in the form of preferred stock to

01:15

fund their operations will that type of preferred stock is

01:18

a direct cousin to the preferred stock of ah public

01:21

company because that one was private The big difference here

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is that a small startup isn't exactly swimming in excess

01:28

cash profits or really any profit In fact most startups

01:31

burn cash like you know it's made of paper but

01:34

many public companies are swimming in cash and their profits

01:38

and they want to give it back to shareholders released

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They have enough cash flow to service debt or preferred

01:42

stock dividends pretty easily so the thought of them paying

01:45

a dividend well forever isn't a crazy thought and along

01:49

the way in their growth While a number of public

01:51

companies raised capital by offering preferred stock to the public

01:55

perhaps the most famous wall street he preferred stock raise

01:58

in history came from goldman one's acts which fearing a

02:01

cash liquidity squeeze harming their business operations in the bottom

02:05

of the mortgage crisis In oh a tone i know

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ten that eric got famed investor warren buffett to buy

02:11

a whole bunch of preferred stock from them So anyway

02:14

what is preferred stock in a public company Well technically

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it's equity as most preferred stock converts into equity at

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some point given a set of triggers mainly that the

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price of equity goes But the distinguishing feature here that

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we care about is that it pays a dividend forever

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until it converts into something else And yes perpetuity equals

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forever That is most preferred Stocks agree to pay a

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set amount like over every ten thousand dollars you own

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we commit to pay thie owner of that ten thousand

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dollars preferred stock set one hundred fifty bucks a quarter

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Well that gives an annual dividend of six hundred dollars

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for a yield their of six percent and every preferred

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stock is different As noted in its trust indenture which

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is sort of the code of hammurabi set out by

02:59

the company issuing the preferred the board can call the

03:02

preferred like buy it back and retire it make it

03:05

go away the dividend then can be stopped at almost

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any time by the board if needed as well or

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even just if they wanted to like just chose to

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stop paying a dividend and a bunch of other factors

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come into play here Key thing is that in a

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normal vanilla preferred stock the cash flows are forever or

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in perpetuity That is when you buy that preferred stock

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you'll be getting that six hundred bucks a year until

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you die and then some something the company remain solvent

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So think ten grand is buying you six hundred bucks

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a year forever and while you can sell that ten

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grand while usually the markets aren't liquid like there aren't

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always tons and tons of buyers for that preferred stock

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the way there are for common shares of coca cola

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But what happens if the overall interest rates suddenly change

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and that reasonably certain to be paid preferred stock which

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carries six percent yield Remember the six hundred box paid

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against ten grand investment The marketplace then becomes more like

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five percent Well then great forever perpetually you'll get that

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six percent a year and it's likely that someone would

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come along and offer you a premium and something like

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a twelve grand for that stream of six hundred dollars

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a year payments as that would now produce a yield

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of five percent which would equal the market rates well

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the scary part happens when it goes the other way

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You have six percent paper but the market now pays

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ten percent and suddenly you're ten grand has market value

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of more like six grand unlike a bond which mercifully

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would finally hit par and pay off and you'd get

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the original ten grand back as your principal that you'd

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invested ages ago and then you could invest that principal

04:38

elsewhere licking your wounds well preferreds and perpetuity sze don't

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have a set ending They are in theory perpetual securities

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they pay forever or as long as the company isn't

04:49

go bankrupt or retire them And if the company does

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want to suspend the preferred dividend well most times they

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have that right and well see cumulative preferred for details

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meaning if they do suspend it then cumulatively the dividend

05:02

a cruise and gets bigger and bigger and bigger and

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they have to pay off all of those dividends usually

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before they can begin paying a dividend on their common

05:09

stock That's a perpetuity just think forever like how long

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you're going to be paying off your student loan debt 00:05:16.955 --> [endTime] Yeah come on get with it