A client bought Rs 1 crore of a bank's perpetual bond at 102, sold to him as a safe 9%. Work out the yield if it is called at par in three years, what happens if it is not called, and the write-down risk it carries.

If called, Hemant earns about 8.2%; if not called, the price could fall to about 82 and his three-year return to about 2.4% a year; if written down, he loses almost everything. Weighting the illustrative branches, his Rs 102 is worth about 121 after three years, less than the 124 from AAA paper at 7.2%. The 9% is the good branch, not the expected return, and the worst branch behaves like equity.

Paying Rs 102 for a Rs 100 voucher that also pays interest means the extra Rs 2 is lost when the voucher is redeemed. Bought above par, a bond that is called at par returns less than its coupon: 9% a year less the 2 points of premium spread over three years gives a yield to call of about 8.2%. That is the best realistic outcome, and it is already below the 9% he was quoted.

Banks usually call these bonds when they can refinance more cheaply, and skip the call when they cannot, which tends to be when the bank or the market is under strain. Then the bond has no maturity, and its price becomes the coupon divided by the yield the market demands: at 11%, 9 divided by 0.11 is about 81.8. Hemant keeps the coupons, if they are paid, but the bond would be worth about 20% less than he paid, and his three-year return falls to about 2.4% a year.

This is the branch that separates the product from a bank deposit. A write-downA clause letting the bank reduce the bond principal, possibly to zero, when its capital falls below a set level or the regulator steps in, without that counting as a default. can wipe out the principal while the bank carries on, so the bondholder can lose everything even if depositors lose nothing. In that branch Hemant receives one 9% coupon and loses the Rs 1.02 crore. That is an equity-like loss on a product he was told was safe.

No, and saying so is the job, gently, because the client was sold something he did not understand. On these illustrative odds, the expected three-year value, about 121.3 per 102, is below plain AAA paper, so the extra coupon does not pay for the risks he is carrying. For a retired client living on the income, the question is not whether the bank is likely to fail, but whether he could live with the not-called or written-down branch. Regulators have tightened who such bonds may be sold to after past write-downs; check the current rules and the bank's capital position before deciding whether to hold.