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Principles of Finance: Unit 5, Perpetuity 4 Views
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Description:
Perpetuity. Gesundheit. Wait, that wasn’t a sneeze? Oh…then what on earth is perpetuity?
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
Full 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
- 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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