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The context is the negative yielding treasuries in Europe (Germany). Here is a quote I found on the matter:

Why would a zero-coupon perpetuity not be worth exactly zero? Because its nominal value adds to the stock of debt of the issuer and so it is an option on recovery value - Michael Jezek, Deutsche Bank

This has a bit too much jargon for me to understand clearly, even after multi-tabbing investopedia.

Question

Can someone explain this concept to me in a very simple way, as if I were your grandma?

  • Is the problem that you don't understand that specific statement or is your grandma interested in zero coupon bonds? If it is that specific statement, it would probably be easier if you had linked to the original manuscript - the statement asks a question that is nonsensical - why indeed should a zero coupon perpetuity be worth exactly zero? That makes no sense at all in any case. – Stian Yttervik Aug 22 at 8:10
  • Are there any provisions requiring the bonds to be repaid in the event of a leveraged buyout (or other circumstances)? What is the seniority of these bonds? – Jasper Aug 23 at 1:25
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Fundamentally it is worth nothing - you are buying a bond that never pays any interest and never has to be repaid.

It's not an investment. It's a financial instrument used to transfer money from the central bank to the government (as an alternative to "printing money").

If a company issued these (none ever has to my knowledge), then there might be some recovery value in a bankruptcy, but they would still have little to no value if the company was healthy.

  • There might also be bond covenants that make the debt senior to hypothetical future issuances of junior securities, and force redemption at (or above) face value if certain covenants are broken. For example, the bond could be redeemed at face value in the event of a leveraged buyout or other large borrowing by the company, or if earnings drop below a certain threshold. – Jasper Aug 23 at 1:23
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Modern money is based on promises rather than intrinsic value.

A $10 bill (banknote / cash) is a promise that its issuer (bank / government) will provide $10 value on presentation of that note. That value is likely to be in the form of another $10 note, but that’s beside the point.

What would you expect to pay for a $10 bill, bearing in mind that you won’t get any interest on holding cash? Probably not $0.

Zero-coupon perpetuities are something like that. They have a face value that’s nonzero, and your quote says that the note represents how much the issuer owes the note holder. That debt gives the note its worth.

  • But money is redeemable. A Zero Perp is not - the issuer never has to pay anything back. – D Stanley Aug 22 at 13:06
  • @DStanley The issuer could call the note, at which time the face value would be repaid. Or if the issuer is wound up, the notes may have some "recovery value", as the quote puts it. Everything else aside, the basis for the quote appears to be that the value of the notes must appear somewhere in the company's accounts. – Lawrence Aug 22 at 13:18
  • Why would the issuer call the note? Issuers only call notes that are worth more than the call value. Why would they pay to get rid of a debt that they never have to repay? – D Stanley Aug 22 at 13:22
  • @DStanley Maybe some kind of Basil x law that affects their capital ratios? – Lawrence Aug 22 at 13:23
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    @Lawrence I'm revising the Basel accords for a professional exam right now and that made me chuckle – MD-Tech Aug 22 at 15:12

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