Canary Call Definition
A canary call refers to a step-up bond that cannot be called once a certain period elapses. After the step-up bond has completed its first-step period, a call cannot be made. A step-up bond is a bond that pays investors a low interest rate at the initial stage but the coupon (interest) increases at regular intervals. The coupon rate moves higher for the remaining period of the bond.
A canary call prohibits an issuer from calling back a step-up bond after its first step has been reached. When the first step is reached, the bond issuer can call back the bond, but after the first-step period has been completed, the bond cannot be called.
A Little More on What is a Canary Call
In reference to a canary call, if a bond issuer decides not to call back the bond until the first-step is completed, the call cannot be made. This means the bond remains a step-up bond and continues to step up to a higher interest rate for the remaining period. The dates at which a step-up bond under a canary call can be made is clearly stipulated in the issue. Step-up bonds typically avail issuers a chance to hedge against decline in interest rates, however, once the first-step period has been completed, this protective measure expires.
A step-up bond with a canary call is often attractive to investors due to the benefit of not being affected by fluctuations in interest rate commonly found in traditional bonds.
Example of a Canary Call
The illustration below will aid a better understand of canary call;
Investor A buys and holds a step-up bond with a canary call option from Issuer B. The initial coupon rate of the bond is 6% and has a life-span of seven years and a step-up period of 2-3 years interval.
If the bond issuer does not call the bond at the first-step period and the coupon rate of the bond increases to 7% after two years, that bond can no longer be called back.
Reference for “Canary call”
Academic research on “Canary call”
A Review of Fannie Mae’s Issuance of Floaters, Step-Ups, and Zero-Coupon Callable Securities, Mae, F., & Mae’s, F. (2009). A Review of Fannie Mae’s Issuance of Floaters, Step-Ups, and Zero-Coupon Callable Securities.
Canaries in the mind: exploring how the financial crisis impacts 21st century future-mindfulness, Wilkinson, A., & Ramirez, R. (2010). Canaries in the mind: exploring how the financial crisis impacts 21st century future-mindfulness. Journal of Futures Studies, 14(3), 45-60. Futures practices have always sought to bridge longer term, context uncertainty and today’s actions. Despite the emergence of diverse foresight lineages, methods and tools, the differences between ‘better proactive foresight’ and ‘better reactive preparedness’ remain unclear. This paper focuses on the 2007-2010 financial crisis in order to clarify misconceptions and confusions concerning ‘scenario planning’. We assess why the crisis is not unique and propose how scenarios might be helpful in overcoming the difficulties of learning from crisis. We focus on how scenarios were used in the run up to this crisis to clarify the nature, role and effectiveness of scenario work. We highlight implications for scholarship and practice, including: overcoming simplistic distinctions of scenarios as products or processes; and as outputs or inputs. We assess the power of scenarios as frames and their role in re-framing strategic conversation; and contrast the misapplication of probability in systemic risk analysis with the co-production of plausibility, between builders and users of scenarios. Finally, we explore why the promises of deploying scenarios to address normal accidents and systemic risks are not yet fully realised.
Canary in the Coal Mine: Can the Campaign for Mandatory Climate Risk Disclosure Withstand the Municipal Bond Market’s Resistance to Regulatory Reform?, Hamilton, L. A. (2010). Canary in the Coal Mine: Can the Campaign for Mandatory Climate Risk Disclosure Withstand the Municipal Bond Market’s Resistance to Regulatory Reform?. William Mitchell Law Review, 36(3), 8.
Are the causes of bank distress changing? Can researchers keep up?, King, T. B., Nuxoll, D., & Yeager, T. J. (2005). Are the causes of bank distress changing? Can researchers keep up?. Since 1990, the banking sector has experienced enormous legislative, technological and financial changes, yet research into the causes of bank distress has slowed. One consequence is that current supervisory surveillance models may no longer accurately represent the banking environment. After reviewing the history of these models, we provide empirical evidence that the characteristics of failing banks has changed in the last ten years and argue that the time is right for new research employing new empirical techniques. In particular, dynamic models that utilize forward-looking variables and address various types of bank risk individually are promising lines of inquiry. Supervisory agencies have begun to move in these directions, and we describe several examples of this new generation of early-warning models that are not yet widely known among academic banking economists.
A Semi‐Explicit Approach to Canary Swaptions in HJM One‐Factor Model, Henrard, M. (2006). A Semi‐Explicit Approach to Canary Swaptions in HJM One‐Factor Model. Applied Mathematical Finance, 13(01), 1-18. Leveraging the explicit formula for European swaptions and coupon‐bond options in the HJM one‐factor model, a semi‐explicit formula for 2‐Bermudan options (also called Canary options) is developed. The European swaption formula is extended to future times. So equipped, one is able to reduce the valuation of a 2‐Bermudan swaption to a single numerical integration at the first expiry date. In that integration the most complex part of the embedded European swaptions valuation has been simplified to perform it only once and not for every point. In a special but very common in practice case, a semi‐explicit formula is provided. Those results lead to a significantly faster and more precise implementation of swaption valuation. The improvements extend even more favourably to sensitivity calculations.