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Simple Description
A perpetuity is an annuity that has no definite end, or a stream of cash payments that continues forever. There are few actual perpetuities in existence (although the British government has issued them in the past, and they are known and still tHIde as consols). A number of types of investments are similar to perpetuities, such as real estate, and the technique for valuing a perpetuity is often useful. Perpetuities are one of the time value of money methods for valuing financial assets. The term annuity is used in finance theory to refer to any terminating stream of fixed payments over a specified period of time. ...
Consols (short for consolidated annuities[]) are a form of British government bond (gilt), dating originally from the 18th century. ...
The time value of money is the premise that an investor prefers to receive a payment of a fixed amount of money today, rather than an equal amount in the future, all else being equal. ...
Detailed Description A perpetuity is an annuity in which the periodic payments begin on a fixed date and continue indefinitely. It is sometimes referred to as a "perpetual annuity". Fixed coupon payments on permanently invested (irredeemable) sums of money are prime examples of perpetuities. Scholarships paid perpetually from an endowment fit the definition of perpetuity. The term annuity is used in finance theory to refer to any terminating stream of fixed payments over a specified period of time. ...
The value of the perpetuity is finite because receipts that are anticipated far in the future have extremely low present value (present value of the future cash flows). Unlike a typical bond, because the principal is never repaid, there is no present value for the principal. The price of a perpetuity is simply the coupon amount over the appropriate discount rate or yield, that is The present value of a single or multiple future payments (known as cash flows) is the nominal amounts of money to change hands at some future date, discounted to account for the time value of money, and other factors such as investment risk. ...
In finance, discounting is the process of finding the current value of an amount of cash at some future date, and along with compounding cash form the basis of time value of money calculations. ...
 Where PV = Present Value of the Perpetuity, A = the Amount of the periodic payment, and r = yield , discount rate or interest rate. Discount rate as used in finance and economics is distinct from the discount rate described below; please refer to discounting and discounts. ...
An interest rate is the price a borrower pays for the use of money he does not own, and the return a lender receives for deferring his consumption, by lending to the borrower. ...
"See how this formula is derived mathematically as well as a formula for valuing a growing perpetuity"
To give a numerical example, a 3% UK government War Loan will trade at 50 pence per pound in a yield environment of 6%, while at 3% yield it is trading at par. That is, if the face value of the Loan is £100 and the annual payment £3, the value of the Loan is £50 when market interest rates are 6%, and £100 when they are 3%.
Real-life examples For example, UK government bonds, called consols, that are undated and irredeemable (e.g. War Loan) pay fixed coupons (interest payments) and trade actively in the bond market. Very long dated bonds have financial characteristics that can appeal to some investors and in some circumstances, e.g. long-dated bonds have prices that change rapidly (either up or down) when yields change (fall or rise) in the financial markets. Consols (short for consolidated annuities[]) are a form of British government bond (gilt), dating originally from the 18th century. ...
A more current example is the convention used in real estate finance for valuing real estate with a cap rate. Using a cap rate, the value of a particular real estate asset is either the net income or the net cash flow of the property, divided by the cap rate. Effectively, the use of a cap rate to value a piece of real estate assumes that the current income from the property continues in perpetuity. Underlying this valuation is the assumption that rents will rise at the same rate as inflation. Although the property may be sold in future (or even the very near future), the assumption is that other investors will apply the same valuation approach to the property. It has been suggested that this article or section be merged with capitalization rate. ...
Net income is equal to the income that a firm has after subtracting costs and expenses from the total revenue. ...
Net cash flow (also called cash flow) is a measure of a companys financial health. ...
Another example is the constant growth Dividend Discount Model for the valuation of the common stock of a corporation. If the discount rate for stocks (shares) with this level of systematic risk is 12.50%, then a constant perpetuity of per dollar of dividend income is eight dollars. However if the future dividends represent a perpetuity increasing at 5.00% per year, then the Dividend Discount Model, in effect, subtracts 5.00% off the discount rate of 12.50% for 7.50% implying that the price per dollar of income is $13.33. A systemic risk is a risk faced by a system, in contrast to a specific risk or unique risk. ...
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