Valuing euro rating-triggered step-up telecom bonds

Abstract

The authors value rating-triggered step-up bonds using three methods: a risk-neutral valuation framework; a similar framework based on historical probabilities; and as plain vanilla bonds. The market seems to value single step-up bonds according to the first model, while it values multiple step-up bonds as plain vanilla bonds. Further, step-up feature market premiums are more volatile than risk-neutral or historical premiums, and the risk-neutral model always approximates market premiums better than the historical method. Finally, most step-up bonds offer a cushion against rating migrations via dampened price movements.