Step-up bonds offer investors scheduled increases in coupon payouts, giving them predictable income that grows over time. This blog explains how they work, where you can invest in them, how they differ from fixed coupon bonds, and who they’re best suited for.
When you start working out, you don’t lift your heaviest weight on day one. You build strength gradually, adding a little more weight, a few more reps, week after week. That steady and predictable progression is what makes the results feel earned.
Similarly, step-up bonds follow a similar pattern in the world of bond markets. But there is a twist: your interest payout grows on schedule, with no effort on your end. While most bonds lock you into a single rate from day one, step-up bonds are designed to increase your returns at fixed intervals. But how do they manage this built-in “rise” that other bonds don’t have?
In this blog, we’ll break down everything you need to know about step-up bonds-from their meaning and structure to how they work and how they stack up against regular fixed-coupon bonds. Let’s get started.
What are Step-up Bonds?
A step-up bond is a debt security where the coupon rate gradually increases or steps up at set intervals. Unlike conventional fixed-rate bonds, you start receiving higher interest payouts automatically over time with a step-up bond.
The issuer company or government of these bonds has to clearly state the fixed schedule of when the set percentage of step-up will occur, along with its frequency, in the bond indenture.
Step-up bonds perform well when interest rates rise gradually, matching the bond’s step-up structure. However, if market rates rise much faster than the scheduled increments, newly issued bonds may offer higher yields, making the step-up bond less attractive for investors.
With the basics in place, the next step is to understand the features that set apart step-up bonds from regular fixed-income securities.
Features of Step-up Bonds
- Scheduled step-ups
Step-up bonds follow a clearly defined interest rate schedule, often increasing annually, semiannually, or at fixed milestones such as every two or three years. The exact step-up percentages (for example, +0.5% every year or +1% every two years) are specified upfront in the bond indenture. Because the entire schedule is disclosed at the time of issuance, investors know precisely how their interest payouts will change through the life of the bond.
- Callable nature
Many step-up bonds include a call option that allows the issuer to redeem the bond before maturity. Issuers typically exercise this option when prevailing market interest rates fall and refinancing becomes cheaper.
- Issuer’s obligation
Issuers of step-up bonds commit to paying higher coupon rates as the bond progresses, regardless of market movements. However, if market rates remain high, redeeming the bond becomes less attractive, and the issuer continues to pay lower scheduled coupons.
These features explained what a step-up bond promises on paper, but the real clarity comes from seeing how those promises turn out in your actual interest payouts. Let’s break down how step-up coupon bonds work in practice.
How Do Step-up Coupon Bonds Work?
Initially, step-up bonds offer a base yield, which is lower compared to other fixed-rated bonds. This base yield acts as the minimum return you’ll receive, helping you understand the starting point and appeal of these bonds. As time passes, the interest payout on these bonds starts to increase. So, the longer you hold on to these bonds, the more you earn.
These step-ups in interest payouts typically occur annually or semiannually. Step-up bonds are usually issued by companies in their early growth phase, which expect to increase their cash flow substantially in the coming years. However, these bonds can also be issued by established corporate entities or governments.
Generally, step-up bonds are callable. Meaning, the issuer can redeem a step-up callable bond before its maturity. Issuers mostly use this feature when the existing interest rates are lower than the bond’s scheduled rates.
The concept of step-up bond becomes far more intuitive when you see the gradual coupon changes mapped out year by year. So, let’s break down a real-world step-up bond example.
A Step-up Bond Example with Increasing Coupon Structure
Let’s say you invest ₹1,00,000 in a 6-year step-up bond issued by a reputed NBFC.
Principal: ₹1,00,000
Tenure: 6 years
Coupon payment frequency: semiannual (twice a year)
Coupon rate: Starts at 6% per annum and increases by 0.5% every two years.
Let’s see how it works with no compounding, to calculate the guaranteed payments you will receive on the principal.
Note: The annual coupon rate is divided by two for each semiannual payment.
| Year | Annual Coupon Rate | Semiannual Coupon Rate | Payment Period | Coupon Payment (on ₹1,00,000) |
| 1 | 6.00% | 3.00% | H1 | ₹3,000 |
| H2 | ₹3,000 | |||
| 2 | 6.00% | 3.00% | H3 | ₹3,000 |
| H4 | ₹3,000 | |||
| 3 | 6.50% (Step-up) | 3.25% | H5 | ₹3,250 |
| H6 | ₹3,250 | |||
| 4 | 6.50% | 3.25% | H7 | ₹3,250 |
| H8 | ₹3,250 | |||
| 5 | 7.00% (Step-up) | 3.50% | H9 | ₹3,500 |
| H10 | ₹3,500 | |||
| 6 | 7.00% | 3.50% | H11 | ₹3,500 |
| H12 + Principal | ₹3,500 + ₹1,00,000 |
Total interest received: ₹3,000 x 4 + ₹3,250 x 4 + ₹3,500 x 4 = ₹12,000 + ₹13,000 + ₹14,000
= ₹39,000
The calculation above only shows the cash you receive. In reality, investors often reinvest their coupon payments. This process, known as compounding, allows you to earn interest on your already earned interest, significantly boosting your final return.
Assumption for compounding: Let’s assume you reinvest every semiannual payment at a consistent 6.00% annual rate (or 3.00% semiannually) from the time you receive it until the bond matures at the end of Year 6.
| Payment Period | Payment Received (C) | Periods Remaining to Maturity (n) | Future Value (FV) of Reinvested Payment (FV = C * (1+r)^n) |
| H1 | ₹3,000 | 11 | ₹3,000*(1 + 0.03)^11 = ₹4,156.41 |
| H2 | ₹3,000 | 10 | ₹3,000*(1 + 0.03)^10 = ₹4,031.75 |
| … | |||
| H11 | ₹3,500 | 1 | ₹3,500*(1 + 0.03)^1 = ₹3,605.00 |
| H12 | ₹3,500 | 0 | ₹3,500*(1 + 0.03)^0 = ₹3,500.00 |
Total future value of all reinvested coupons (simplified sum):
If we were to sum the Future Value (FV) of all 12 payments, the total accumulated value from the coupons (the Total Interest plus the interest earned on the interest) would be significantly higher than the simple ₹39,000.
| Simple Interest | Total Return with Compounding | Principal Repaid |
| ₹39,000 | > ₹39,000 | ₹1,00,000 |
The total return on a bond is maximized when the coupon payments are regularly reinvested and compounded over time, which is a crucial factor to consider alongside the step-up feature.
Where are Step-up Bonds Available in India?
Step-up bonds can be bought and sold in India. However, their availability and active trading volumes can vary depending on the specific issuers and market conditions. These bonds are accessible to investors through multiple regulated channels, each catering to different types of issuers, from government-backed securities to corporate offerings.
1. Brokerage platforms
Most registered online brokerages list step-up bonds that are traded on stock exchanges. These platforms make it easy for investors like you to browse available options, compare yields, and invest seamlessly through your existing trading accounts.
2. Banks and financial institutions
Several leading banks provide investors with access to bond investments through their investment or wealth management desks. Customers can invest in both primary issuances and secondary market offerings of step-up bonds directly through their banking relationship.
3. RBI Retail Direct portal
For government or RBI-issued step-up bonds, the RBI’s Retail Direct platform serves as the official gateway for individual investors. It enables direct, commission-free participation in sovereign bonds without needing intermediaries.
4. Direct issuer portals
Certain corporations and NBFCs open subscriptions to their step-up bonds through their own websites during new issues. This route can sometimes offer investors exclusive access or promotional rates during the subscription window.
Step-up Bonds vs Regular Fixed Coupon Bonds
| Parameter | Step-up Bonds | Regular Fixed Coupon Bonds |
| Coupon | Coupon rate increases at scheduled intervals as specified in the bond indenture | Coupon rate remains the same throughout the bond’s tenure |
| Maturity | Usually medium to long term; may be redeemed early if the bond is callable | Fixed maturity; held till maturity unless sold on the secondary market |
| Return Stability | Returns rise over time but are always subject to the risk of early call by the issuer | Returns remain stable and predictable from start to end |
| Issuer Flexibility | Higher; issuers often have the option to call back the bond when market interest rates fall | Limited; most fixed coupon bonds don’t include call provisions unless specifically structured |
Who Should Consider Investing in Step-up Bonds?
Step-up bonds are a great fit for someone who likes steady passive income and appreciates knowing exactly how their returns will grow over time; without constantly tweaking their portfolio. They become even more appealing for investors when interest rates are expected to rise, since the increasing coupon structure can work in your favor.
If this sounds like you, it may be worth taking a closer look at these bonds. Just make sure you understand how to evaluate them, compare a few options, and reach out to a professional if you feel unsure at any point.
