If you have a perpetual bond that can be called after 3 years. It was issued when the 1 year interest rate was at 10%, in year 2 the one year interest rate increased to 20% and finally in year 3 the one year interest rate is 15%. For year 4 the interest rate can go up to 20% (70% likelihood) stay flat to 15% (10%) and down to 10% (20% likelihood). Would the company call the bond if the rate goes to 10%. I would assume not as the one year interest rate would be identical to the one when they issued it and not below the 10%. If they would call it why would they? Assume that the coupon rate is 20%.
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Pan European Monkey, sorry about the lack of response. Maybe one of these topics will help:
I hope those threads give you a bit more insight.
Bump
I don't think they would call it, all other things being equal. If a 10 point spread (20% coupon -10% interest rate) made sense when they issued it, it makes sense now, especially since it's a perpetual bond and they aren't taking refi/rate risk.
The exception might be if the company's credit profile had improved in the three years since issuance, i.e. whatever they invested the proceeds of the bond in are now showing up in the financials (more cashflow, less net leverage). In that case maybe they can issue new debt, and maybe less of it, at something lower than the 20% they're paying on the original bond.
Thanks that was my instinct too...
a perpetual bond has no maturity...and so should not be compared to the 1 year interest rate....but rather, you should be comparing it to a longer rate, such as the 30yr.
however, when the reference rate goes from 10%-->20%, that implies a dollar price drop on a perpetual from 100 --> 67
so, when interest rates rise 10 points, the company can retire 100mm of perpetual debt for 67mm. This seems like a great deal, if they can afford to...as a 20% interest rate is not something you want to sustain for very long.
this wasn't a real life example, it is just about the logic behind calling bonds for a finance module whereby this odd question came up.
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