What is Canary Call?
Figuring out Canary Call
With a canary call, the issuer of the bond reserves the option to call back the bond until the stated step-up date, yet can't call it back after that point. Typically, the stated period is the initial step-up date after which the coupon climbs to a higher rate for the leftover periods.
Thus, after a canary call pays an initial coupon rate for the principal designated period, the issuer is left with the terms until the bond arrives at its maturity date. Basically, when the callable period is past, a canary call returns to a non-callable step-up bond, where the coupon rate will increase with each step-up period.
A canary call might be exercised exclusively on foreordained dates. In like that, it is like a Bermuda option, where the holder has the privilege to exercise that option at pre-decided stretches, or dates, through the life expectancy of the contract.
One advantage for issuers of step-up bonds is that it offers them a protective strategy against falling interest rates. With a canary call option, the issuer loses that advantage once the initial step-up period has passed. Canary calls can make step-up bonds more appealing to investors.
Step-up bonds are alluring to investors since they are not affected as much by interest rate variances as are traditional bonds. Step-up bonds as a rule, and canary calls specifically, are particularly interesting to investors when interest rates are expected to be flat, or restricted to a narrow reach.
Canary Call Example
Think about the accompanying scenario: Acme Company issues a seven-year bond with a canary call option. The initial coupon rate is 6 percent. The rate steps up to 7 percent following three years, which is the initial step-up period. Subsequent step-up periods are scheduled consistently after that.
At the four-year mark, the open-market rate has dropped to 5 percent. As of now, Acme Company couldn't imagine anything better than to call the bond and reissue the debt at the lower market interest rate. Be that as it may, Acme can not do as such, as the call back option expired after the initial step-up point, which happened at the three-year mark.
- Canary calls are more appealing to investors as the issuer loses the call advantage once the initial step-up period has passed.
- Canary calls are particularly interesting to investors when interest rates are expected to be flat, or restricted to a narrow reach.
- A canary call is a type of step-up bond where the coupon rate increases at foreordained dates and that can't be called after a certain stated period.