Accounting for Step-Up Bond
Step-Up Bond is the type of bond in which the initial interest is lower but keeps increasing over time untill the maturity date. The term of bond will set the initial rate and growth rate over the time period. The initial interest rate usually below the average investment and it keeps increasing over the bond lifetime.
The investors enjoy regular cash inflow and allow to earn higher rates in the future. Step Up Bond provide benefit to the holders while having some negative impact on the issuers.
Step Up Bond Example
Company ABC issues the step-up bond at $ 1,000 per bond. The initial coupon rate was 2%, and it will keep increasing 50% every year over the 5 years lifetime.
| Year | Coupon Rate | Interest Payment |
| 1 | 2% | $ 20 |
| 2 | 3% | $ 30 |
| 3 | 4.5% | $ 45 |
| 4 | 6.75% | $ 67.5 |
| 5 | 10.125% | $ 100.125 |
As we can see the interest rate keeps increasing from the year until the maturity date. However, the growth percentage may different depend on the bond term. Some bonds use exact percentages to represent increases from year to year. Some bonds increase only one or two times during the lifetime.
Single Step-Up Bond
A single step-up bond is a step-up bond in which the coupon rate only increases one time over the lifetime. As we can see in the example above, the coupon rate increases 5 times before reaching the maturity date. The single step-up bond only increases one time.
Multi Step-up Bond
Multi Step-up bond is the step-up bond in which the coupon rate increases more than one before the maturity date.
Advantage of Step Up Bond
- High return for investors: Investors will receive more return by investing in step-up bonds, the interest rate will keep increasing over time. If compared to normal bonds, the step-up bonds will generate higher returns.
- Highly liquidate: Due to the nature of this bond, they are very popular among investors. The demand is higher than a normal bond. Due to this reason, selling off step-up bonds is not the problem. It is very easy to convert to cash.
- Stable market price: The price will of the normal bond change depending on the market interest rate. Bonds price will decrease when interest rate increase as the investor will sell of low-interest rate bond. However, it will not happen to the step-up bond as the rate always increase.
Disadvantage of Step Up Bond
- Callable: callable is the option that allows the issuer to redeem the bonds before the maturity date. If the bonds have this option, they may be redeemed before reaching the higher interest rate.
- Interest rate increases slower than market: The coupon rate of step-up bond will keep increasing however, it may be lower than the market rate. The market price will drop when the market interest rate is higher than the bond rate.
- Lose if early sale: The investors will face a loss if they decide to sell too early.