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The coupon rate is stated as an annual percentage rate based on the bond’s par, or face value. The dollar amount represented by this coupon rate is paid each year—usually on a semiannual basis—to the bondholder until the bond is redeemed at maturity. The coupon rate of a bond or other fixed income security is the interest rate paid out on the bond. When the government or a company issues a bond, the rate is fixed. A bond’s yield, or coupon rate, is computed by dividing its coupon payment by its face value. An updated yield rate can be computed by dividing its coupon by the current market price of the bond.
What is the relationship between coupon rate and interest rate risk?
Bonds offering lower coupon rates generally will have higher interest rate risk than similar bonds that offer higher coupon rates.
The amount of interest that is paid out is considered the coupon payment. In our illustrative scenario, we’ll calculate the coupon rate on a bond issuance with the following assumptions. We call it a ‘coupon’ because, in the past, bonds used to have coupons.
Par Value at Maturity
Thus, if a bond has a par value of 1,000 and a coupon rate of 10,100 a year during the time between when the bond is issued and when it matures. It can also vary with a money market index, such as LIBOR, or it can be even more exotic. The bond will also specify when the interest is to be paid, whether monthly, quarterly, semi-annually, or annually. Unlike other financial products, the dollar amount is fixed over time. For example, a bond with a face value of $1,000 and a 2% coupon rate pays $20 to the bondholder until its maturity. Even if the bond price rises or falls in value, the interest payments will remain $20 for the lifetime of the bond until the maturity date.
The term “coupon rate” comes from a physical coupon on bond certificates which was clipped and presented for payment on the day the interest payments were due. Poor credit rating is an indicator that a bond issuer has a higher chance of “defaulting”, or being financially unable to pay back the loan. For example, if the coupon rate is 8%, then the issuer pays $80 of interest per year on a bond that has a $1,000 face value.
Coupon rate vs. yield
Investors seek this premium to compensate for the erosion in the value of their capital due to inflation. The spread is determined coupon rate vs interest rate at auction when the FRN is first offered. The spread is the highest accepted discount margin in that auction.
So, the coupon rate is the amount of yield paid by the issuer to their purchasers, but it is a certain percentage amount calculated on the face value. A bond’s coupon rate can be calculated by dividing the sum of the security’s annual coupon payments and dividing them by the bond’s par value. For example, a bond issued with a face value of $1,000 that pays a $25 coupon semiannually has a coupon rate of 5%. All else held equal, bonds with higher coupon rates are more desirable for investors than those with lower coupon rates. Par value is the amount of money a holder will get back once a bond matures; a bond can be sold at par, at a premium, or at a discount. The coupon rate is the amount of interest that the bondholder will receive per payment, expressed as a percentage of the par value.
Is the coupon rate on a bond its interest rate?
The coupon rate is the interest rate paid on a bond by its issuer for the term of the security. The term "coupon" is derived from the historical use of actual coupons for periodic interest payment collections.