debt prior to maturity and re-issue at lower interest rates. Conversely, if market rates rise to 10 (Scenario C) and Company XYZ pays only 8 for its debt, then the firm will have a favorable cost of debt. 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). The aforementioned bonds wont provide sky-high yields, but will offer investors marginal income enhancement in their portfolios when well researched and analyzed on a relative and absolute basis. For many reasons we do not like the idea of buying very long dated municipal bonds, and if you see a bond with a maturity outside our typical buying length do not be alarmed, it is very likely pre-refunded. Understandably, todays yields have some investors and retirees questioning government policy and scrambling to find the income they need for living expenses. If the bond is not called, and matures on 5/22/18, were picking up around 10 basis points (0.10) on a comparable bullet (non-step, non-call) agency bond. Because the coupon payment increases over the life of the bond, a step-up bond lets investors take advantage of the stability of bond payments while benefiting from interest rate increases. To assess the risk-neutral rating transition probabilities necessary to price these bonds, we introduce a new calibration method within the reduced-form rating-based model of Jarrow, Lando, and Turnbull (1997).
We buy bonds of sound corporations, even if they carry this provision, knowing it is unlikely that it will be exercised and that we may add value either through a rockauto coupon code free shipping slightly higher yield to maturity or a significantly higher annualized return should the bond. If you would like a list of all fixed income securities purchased in the last year, please contact. . For example, a multi-step bond pays 3 the first and second years, 4 the third and fourth years, and 5 the fifth year. This compares favorably to a bond that simply matures on 5/22/15 and yields around.2 (so weve picked up over 115 basis points). Think of pre-refunded bonds as you would think about refinancing a mortgage. The major reason we like these bonds is that we are compensated for the added uncertainty of when the bond will mature or be called with enhanced yield to maturity, a higher current yield (coupon and the chance to have a very nice return. We also treat split ratings and adjust for rating outlook. The benefit to us as the bondholder is that they must pay us a handsome premium to do so (in complex terms a callable bond exhibits negative convexity while a bond with a make whole call is actually positively convex). . Because most step-up bonds are callable on the step-up date, the issuer may force redemption of the bonds. Step-up bonds have been issued in large amounts in the European telecom sector, and we find that, through most of the sample, step-up bonds issued by the two largest issuers have traded at a discount relative to comparable fixed-coupon bonds from the same issuers. We will explore three areas that open up added value without adding credit* risk: Step-up bonds, pre-refunded bonds, and bonds with make whole call options.
Corporate bonds with provisions stating that the coupon payments increase as the credit rating level of the issuer declines. 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. With the rock bottom interest rate era (as measured by the Federal Funds Target Rate) entering its 6th year, investors who rely upon interest income have likely read close to 1,000 different articles and editorials pontificating upon where to find high yielding investments. Some investors view step-up bonds as buy-and-hold investments because they are less sensitive to interest rate changes than traditional bonds are.