A coupon or coupon payment is the annual interest rate paid on a bond, expressed as a percentage of the face value and paid from issue date until maturity. Coupons are usually referred to in terms of the coupon rate (the sum of coupons paid in a year divided by the face value of the bond in question).
For example, a $1,000 bond with a coupon of 7% pays $70 a year. Typically these interest payments will be semiannual, meaning the investor will receive $35 twice a year.
Because bonds can be traded before they mature, causing their market value to fluctuate, the current yield (often referred to simply as the yield) will usually diverge from the bond's coupon or nominal yield. You can calculate the bond's total annual payment easily using software such as Excel.
For example, at issue, the $1,000 bond described above yields 7%; that is, its current and nominal yields are both 7%. If the bond later trades for $900, the current yield rises to 7.8% ($70 ÷ $900). The coupon rate, however, does not change, since it is a function of the annual payments and the face value, both of which are constant.
Coupon rate or nominal yield = annual payments ÷ face value of the bond
Current yield = annual payments ÷ market value of the bond
The term "coupon" originally refers to actual detachable coupons affixed to bond certificates. Bonds with coupons, known as coupon bonds or bearer bonds, are not registered, meaning that possession of them constitutes ownership. To collect an interest payment, the investor has to present the physical coupon.
Bearer bonds were once common. While they still exist, they have fallen out of favor for two reasons. First, an investor whose bond is lost, stolen, or damaged has functionally no recourse or hope of regaining their investment. Second, the anonymity of bearer bonds has proven attractive to money launderers. A 1982 U.S. law significantly curtailed the use of bearer bonds, and all Treasury-issued bearer bonds are now past maturity.
Today, the vast majority of investors and issuers alike prefer to keep electronic records on bond ownership. Even so, the term "coupon" has survived to describe a bond's nominal yield.
What's the Difference Between Coupon Rate and Coupon Rate Yield?
A bond's coupon rate is the rate of interest the bond pays annually, while the yield is the rate of return that the bond generates.
How Are Bond Coupons Affected by Market Interest Rates?
The bond issuer decides on the coupon rate based on the market interest rates, which change over time, causing the value of the bond to increase or decrease. However, the bond's coupon rate is fixed until maturity. Therefore, bonds with higher coupon rates can provide some safety against rising market interest rates.
Who Pays the Bond Coupon?
The bond issuer pays coupon bondholders the face value of the debt, plus interest.
The Bottom Line
The coupon rate of a bond can help investors know the amount of interest they can expect to receive until the bond matures. It can also help determine the yield if the bond was purchased on the secondary market. Investors can use the fixed dollar amount of interest to determine the bond’s current yield, and then decide if this is a good investment for them.
A bond coupon can also be used to gauge a bond against other income-producing investments, like mutual funds, certificates of deposit, stocks, etc. to make informed decisions on which investment works best.
A coupon or coupon payment is the annual interest rate paid on a bond, expressed as a percentage of the face value and paid from issue date until maturity. Coupons are usually referred to in terms of the coupon rate (the sum of coupons paid in a year divided by the face value of the bond in question).
How Bond Coupon Rate Is Calculated. The coupon rate is calculated by adding up the total amount of annual payments made by a bond, then dividing that by the face value (or “par value”) of the bond.
If an investor purchases a $1,000 ABC Company coupon bond and the coupon rate is 5%, the issuer provides the investor with a 5% interest every year. This means the investor gets $50, the face value of the bond derived from multiplying $1,000 by 0.05, every year.
These bonds typically pay out a semi-annual coupon. Owning a 10% ten-year bond with a face value of $1,000 would yield an additional $1,000 in total interest through to maturity. If interest rates change, the price of the bond will fluctuate above or below $1,000, but the $100 per year of interest will remain the same.
The coupon rate of a bond is its interest rate, or the amount of money it pays the bondholder each year, expressed as a percentage of its par value. A bond with a $1,000 par value and coupon rate of 5% pays $50 in interest annually until it matures.
The value of coupon payments will be $225. Explanation: The following equation helps determine the coupon value: Coupon payment per period = Face value of the bond × Coupon rate × Coupon period/Total period.
As a rule of thumb, if a coupon rate is higher than the prevailing market interest rate, the bond's price rises; if the coupon is lower, the bond's price falls.
Upon the issuance of the bond, a coupon rate on the bond's face value is specified. The issuer of the bond agrees to make annual or semi-annual interest payments equal to the coupon rate to investors. These payments are made until the bond's maturity.
Bonds are more beneficial for investors who want less exposure to risk but still want to receive a return. Fixed-income investments are much less volatile than stocks, and also much less risky.
The issuer pays coupon bondholders the face value of the debt plus interest over time, which is why these types of bonds' rates tend to be higher than regular fixed-income securities.
For example, a $1,000 bond with a coupon of 7% pays $70 a year. Typically these interest payments will be semiannual, meaning the investor will receive $35 twice a year.
What causes bond prices to fall? Bond prices move in inverse fashion to interest rates, reflecting an important bond investing consideration known as interest rate risk. If bond yields decline, the value of bonds already on the market move higher. If bond yields rise, existing bonds lose value.
When an investor purchases a bond, he/she expects to be paid interest by the bond issuer. However, the value of the bond is likely to increase or decrease with changes in the market interest rates. If interest rates go up, it results in a decline in the value of the bond. The bond must, therefore, sell at a discount.
Discount bonds come with a high probability of appreciating in value as long as the bond issuer does not default. If the investors hold their bonds until maturity, they will be paid an amount equal to the par value of the bond, even though they initially paid an amount that is less than the bond's par value.
If an investor purchases a bond at par or face value, the yield to maturity is equal to its coupon rate. If the investor buys the bond at a discount, its yield to maturity will be higher than its coupon rate. A bond purchased at a premium will have a yield to maturity lower than its coupon rate.
If a $5,000 coupon bond has a coupon rate of 13 percent, then the annual coupon payment can be calculated by multiplying the face value of the bond by the coupon rate. Thus, the annual coupon payment is $5,000 multiplied by 13%, which equals $650.
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