Question

Presents highly accurate and appropriately detailed advice on how to account for Step-up Bond at issuance, interest dates and maturity based on Australian accounting standards

Answer 1

step-up bond is a bond that pays an initial coupon rate for the first period, and then a higher coupon rate for the following periods. These bonds are often purchased by individuals or portfolio managers who wish to hold fixed income securities with similar features to Treasury Inflation-Protected Securities (TIPS) but with a higher coupon. For example, a five-year bond paying a 4% coupon for the first two years and a 6% coupon for the final three years most likely offers a coupon below current rates at the time of inception, compensating the seller for offering higher coupons in coming periods.
Many step-up bonds are callable, which gives issuers some protection against falling interest rates. For example, if after three years the XYZ bond is paying 8% but market rates are down to 5% (Scenario A), Company XYZ would be paying a relatively high interest rate on its debt. It would probably call the bonds and reissue the debt at a lower rate. In fact, if rates simply stay the same (Scenario B), Company XYZ will probably call the bond. 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.