Multi coupon bonds
Step-up bonds are often issued by government agencies. Let's consider a five-year step-up bond issued by Company XYZ. The initial coupon rate on a step-up bond is usually above market.
Many step-up bonds are callable, which gives issuers some protection against falling interest rates. It would probably call the bonds and reissue the debt at a lower rate. There are several advantages to step-up bonds: They offer coupon payments that somewhat offset inflation , they usually come from high-quality issuers, and they are fairly liquid.
Another advantage is that step-up bonds lessen the interest-rate risk for the investor because increasing rates provide a better yield as long as the bond is not called.
How They Work
Some investors view step-up bonds as buy-and-hold investments because they are less sensitive to interest rate changes than traditional bonds are. If rates rise, for example, the prices of step-up bonds don't fall as much as a similar noncallable bond this is because of future increases in the coupon rate.
If rates fall, the price of a similar noncallable bond tends to increase more than the step-up's price. The promise of higher future coupon payments provides a way for income investors to earn increasingly higher yields on their holdings. However, the callable nature of most step-up bond s means that those returns can be elusive -- the high rates promised in later years will not materialize if the issuer calls the bonds.
It is important to note that callable step-ups have more call risk than traditional callable bonds. This is because, as we saw in the above example, issuers of step-up bonds often call their bonds even if interest rates simply stay flat. Issuers of traditional callable bonds, on the other hand, typically don't call their bonds unless rates go up. Essentially, investors can count on their step-up bonds being called unless interest rates rise higher and faster than the coupon rate on those bonds.
For this reason, step-up bonds are more attractive when rates are expected to rise quickly and to a level above the step-up rates. This, of course, requires research and some speculation on the investor's part. Show 5 More. Interest paid on bonds is usually referred to as coupon. In simple words, a bond is a loan taken at a certain rate of interest for a definite time period and repaid on maturity.
A bond is similar to the loan in many aspects however it differs mainly with respect to its tradability. A bond is usually tradable and can change many hands before it matures; while a loan usually is not traded or transferred freely. The entities that borrow money by issuing bonds are called as issuers.
Step-Up Bond
In the US, there are mainly 4 major issuers of bonds which include the government, government agencies, municipal bodies, and corporates. Every bond that is issued has a face value; which is usually the principal amount that is borrowed and returned on maturity. Every bond is usually rated by credit rating agencies; higher the credit rating lower will be the coupon required to pay by the issuer and vice versa.
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- 1) What are Bonds??
The coupon payments on the bond usually have a payment frequency. The coupons are usually paid annually or semi-annually; however, they may be paid quarterly or monthly as well.
The effective return that the investor makes on the bond is called as a return. If the holding period is considered for a year this is referred to as current yield and if it is held to maturity it is referred to as yield to maturity YTM. There are many types of bonds issued that differentiate each other in respect of their features. These features vary depending upon the requirement of the issuer.
Let us have a look at some of the major types of bonds issued. A plain vanilla bond is a bond without any unusual features; it is one of the simplest forms of bond with a fixed coupon and a defined maturity and is usually issued and redeemed at the face value. It is also known as a straight bond or a bullet bond. A zero coupon bond is a type of bond where there are no coupon payments made. The difference will be the yield for the investor.
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These are also called as discount bonds or deep discount bonds if they are for longer tenor. This type of bond is a blend of a coupon-bearing bond and a zero coupon bond. These bonds do not pay any coupon in the initial years and thereafter pay a higher coupon to compensate for no coupon in the initial years. Such bonds are issued by corporates whose business model has a gestation period before the actual revenues start.
Examples of a company which may issue such type of bonds include construction companies.
These are bonds where the coupon usually steps up after a certain period. They may also be designed to step up not once but in a series too. These are also called as a dual coupon or multiple coupon bonds. These are just the opposite of Step-Up Bonds. These are bonds where the coupon usually steps down after a certain period. They may also be designed to step down not once but in a series too.
Floating rate bonds are so called because they have a coupon which is not fixed but rather linked to a benchmark. These types of bonds are similar to the floating rate bond in that the coupon is not fixed and is linked to a benchmark; however, the differentiating thing is that the rate is inversely related to the benchmark. In simple words, if the benchmark rate goes up; the coupon rate comes down and vice versa.
Extendable bonds are bonds that allow the holder to enjoy the right to extend the maturity if required. The holder has an additional benefit in this case because if the rate of interest in the market reduces, the holder may choose to extend the tenor and enjoy the higher rate of interest in terms of coupon payment.
With a multi-step bond, the coupon increases multiple times, according to a preset schedule. For example, a multi-step bond pays 3% the first. A coupon bond is a debt obligation with coupons attached that represent semiannual interest payments, also known as a "bearer bond.".
For this benefit, the holder may enjoy the coupon rates that are usually lower than a plain vanilla bond. These are types of bonds which allow the issuer and the bondholders to reset the coupon rate based on the then prevailing market scenario. This is not linked to any benchmark but on the basis of renegotiation between the issuer and the bondholders. This is usually the case where bond tenor is very long.