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Principles of Finance: Unit 5, Perpetuity 4 Views


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

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Transcript

00:00

Principles of finance ah la shmoop perpetuity forever doesn't always

00:06

mean forever does not sound like a perfume or something

00:09

Anyway the topic here is ah perpetuity a special kind

00:13

of forever paying security But in practical reality we're goingto

00:19

map the notion of a perfect ooh ity onto a

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

01:24

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

01:40

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

02:08

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

02:17

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

02:21

some point given a set of triggers mainly that the

02:24

price of equity goes But the distinguishing feature here that

02:27

we care about is that it pays a dividend forever

02:30

until it converts into something else And yes perpetuity equals

02:35

forever That is most preferred Stocks agree to pay a

02:38

set amount like over every ten thousand dollars you own

02:41

we commit to pay thie owner of that ten thousand

02:44

dollars preferred stock set one hundred fifty bucks a quarter

02:47

Well that gives an annual dividend of six hundred dollars

02:50

for a yield their of six percent and every preferred

02:53

stock is different As noted in its trust indenture which

02:56

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

03:08

any time by the board if needed as well or

03:10

even just if they wanted to like just chose to

03:13

stop paying a dividend and a bunch of other factors

03:15

come into play here Key thing is that in a

03:17

normal vanilla preferred stock the cash flows are forever or

03:21

in perpetuity That is when you buy that preferred stock

03:24

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

03:27

you die and then some something the company remain solvent

03:30

So think ten grand is buying you six hundred bucks

03:33

a year forever and while you can sell that ten

03:35

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

03:39

always tons and tons of buyers for that preferred stock

03:42

the way there are for common shares of coca cola

03:45

But what happens if the overall interest rates suddenly change

03:48

and that reasonably certain to be paid preferred stock which

03:52

carries six percent yield Remember the six hundred box paid

03:55

against ten grand investment The marketplace then becomes more like

03:58

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

04:03

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

04:06

come along and offer you a premium and something like

04:08

a twelve grand for that stream of six hundred dollars

04:11

a year payments as that would now produce a yield

04:14

of five percent which would equal the market rates well

04:17

the scary part happens when it goes the other way

04:19

You have six percent paper but the market now pays

04:22

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

04:26

of more like six grand unlike a bond which mercifully

04:29

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

04:32

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

04:35

invested ages ago and then you could invest that principal

04:38

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

04:43

have a set ending They are in theory perpetual securities

04:47

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

04:49

go bankrupt or retire them And if the company does

04:52

want to suspend the preferred dividend well most times they

04:54

have that right and well see cumulative preferred for details

04:58

meaning if they do suspend it then cumulatively the dividend

05:02

a cruise and gets bigger and bigger and bigger and

05:04

they have to pay off all of those dividends usually

05:07

before they can begin paying a dividend on their common

05:09

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

05:14

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

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