Fixed Income

• Taxable Fixed Income
  • Bond Market Monthly
• Municipal Bonds
  • The Basics
  • Commentary
  • Municipal Bond New Issues
  • Taxable Equivalent Yield Calculator
• Fixed Income High Net Worth
  • Getting Started
  • Program Components
• FDIC-Insured CDs
  • Features & Benefits
  • FDIC Insurance
  • CD Rates
• Auction Rate Securities

Taxable Fixed Income

Investment Types: Step-up Notes

If, like many investors, you've been waiting and hoping that interest rates go up rather than committing your money in the current interest rate environment, then you might want to consider step-up notes.

Step-up notes are multi-coupon notes with each subsequent coupon higher than the prior coupon. Most are issued as callable bonds with the initial coupon fixed until the first call date. At that time, if the bond is not called, the coupon increases or steps up to the next highest coupon.

Accordingly, even if the issuer calls the bond on the first possible call date, investors will have earned an attractive return when compared to other short-term investments whose maturity equals the no-call period. Conversely, if the step-up notes are not called, interest income increases as the bond approaches its maturity date. If rates do rise, the step-up's coupons are more likely to provide for an attractive current yield when compared to fixed interest notes even in a new, higher interest rate environment. And if rates increase only modestly, the investor is likely to earn more on the step-up note than could be earned on many alternative fixed-income investments.

Additional Considerations

While there is an active secondary market for step-up notes, thus allowing an investor to sell them prior to maturity, step-ups should be considered as a buy-and-hold investment. If sold prior to maturity, market conditions may cause the resale price to be higher or lower than the purchase price. Assuming the price of a standard noncallable bond increases if interest rates trend lower, the price of a step-up note of similar maturity and issuer will be limited due to the increased likelihood that the bond would be called at par ($1,000). On the other hand, assuming the price of a noncallable bond will decrease if rates trend higher; all else being equal, the price of a step-up note should decline at a slower rate as a result of the increase of the coupon over time.

In summary, step-up notes should be less volatile than either standard noncallable bonds or standard callable bonds, both in increasing and decreasing interest rate environments. Of course, when the notes are not called and are held to maturity, investors will receive par (typically $1,000 per bond). Step-ups are most frequently issued by Government Sponsored Enterprises (GSEs), investment-grade corporations and FDIC-insured institutions as Certificates of Deposit (CDs).

For further information about multi-coupon step-up notes, please contact your Financial Advisoradvisor.