Step-Up Bond
Quick Definition
A bond with a coupon rate that increases at predetermined intervals over its life, providing rising income to investors.
Key Takeaways
- Coupon rate increases at predetermined intervals
- Provides rising income and partial inflation protection
- Commonly issued by GSEs and financial institutions
- Often callable at each step-up date, limiting upside potential
What Is Step-Up Bond?
A step-up bond features a coupon rate that increases at specified dates according to a predetermined schedule written into the bond indenture. For example, a 10-year step-up bond might pay 3% for the first three years, 4% for years four through six, and 5% for the remaining years. Step-up bonds appeal to investors who want rising income over time and provide partial protection against inflation and rising rates. They are commonly issued by government-sponsored enterprises (GSEs) like the Federal Home Loan Banks and by financial institutions. Many step-up bonds include call provisions that allow the issuer to redeem the bond at each step-up date, meaning the higher coupons only materialize if the issuer chooses not to call.
Step-Up Bond Example
- 1A Federal Home Loan Bank step-up note pays 3.5% for year 1, 4.0% for year 2, and 4.5% for years 3–5, callable at each step-up date
- 2An investor buys a step-up bond hoping rates won't fall — if rates drop, the issuer will call the bond before the higher coupons kick in
Related Terms
Coupon Rate
The annual interest rate stated on a bond, expressed as a percentage of face value, that determines the periodic coupon payments.
Callable Bond
A bond that gives the issuer the right to redeem it before maturity at a specified price, typically when interest rates fall.
Floating Rate Bond
A bond whose coupon rate adjusts periodically based on a reference interest rate, providing protection against rising rates.
Agency Bond
A bond issued by a government-sponsored enterprise (GSE) or federal agency, offering higher yields than Treasuries with near-government credit quality.
Bond
A fixed-income debt security where investors loan money to an issuer in exchange for regular interest payments and return of principal at maturity.
Treasury Bond (T-Bond)
A long-term U.S. government debt security with a maturity of 20 or 30 years, paying semiannual coupon interest.
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