Monday, April 5, 2010

The Debts of the Spenders: Bond Buyers Demand Protection Against Downgrades

Step-up bonds are bonds whose interest increases if a borrower is downgraded (but not defaulted). According to a report by Bloomberg, sales surged to $37.3 billion in March, or 12.4 percent of all debt issued.

Please note that most of these bonds are issued by PRIVATE companies as opposed to sovereign entities such as national and/or local governments (Greece and various American cities/states/local governments come to mind).

Moreover, it is important to distinguish step-up bonds from credit default swaps as they focus on interest rate increases as opposed to an outright insurance payment (which is usually triggered only by default. This response is not unusual considering that the greatest inflow into bond funds by investors occurred in 2009. There is not much room left for additional gain so those corporate issuers late to the refinancing party must offer additional incentives to attract increasingly discerning lenders.

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