Step up coupon bonds

Step up coupon bonds are structured so that the coupon rate increases over time according to a predetermined schedule. Typically, step-up coupon bonds have a call feature that allows the firm to redeem the bond issue at a set price at each step up date. If the new higher coupon rate is greater than what the market yield would be at the call price, the firm will call the bonds and retire them. This means if market yields rise, a bondholder may, in turn, get a higher coupon rate because the bonds are less likely to be called on the step up date.

Yields could increase because an issuer’s credit rating has fallen, in which case the higher stepup coupon rate simply compensates investors for greater credit risk. Aside from this, we can view step up coupon bonds as having some protection against increases in market interest rates to the extent they are offset by increases in bond coupon rates.