Coupon rate meaning
A coupon rate is a yield that is paid out for a fixed-income security such as a government and corporate bond. A coupon rate for a fixed-income security represents an annual coupon payment that the issuer pays according to the bond’s par or face value.
The coupon payment on a bond is the interest payment received by the holder of the bond until the bond matures.
Coupon rate formula
The coupon rate calculations formula is simple. It is calculated by dividing the sum of the annual coupon payments for the security by the bond’s par value. Par value determines the bond’s maturity value and dollar value of coupon payments. The bond’s market value can be higher or lower than its par value, depending on the interest rate level and credit status of the bond.Investors are more interested in bonds with higher coupon rates than those which provide lower coupon rates. The coupon rate is determined at the bond’s issuance date and remains the same, meaning that holders of the bond get fixed interest payments at a predefined time frame.
You should note that results of the bond investment depend on changing interest rates on the market. As the coupon rate of the bond is fixed through the bond’s maturity, the holder of the bond will receive the predefined interest payments regardless of the interest rate offered by the market, although it can be higher. Therefore, bonds with higher coupon rates provide some sort of protection from raising market interest rates.
Investors buying the bond at its face value and holding it up to maturity get the interest based on the coupon rate predefined at the bond’s issuance. Investors buying the bond on the secondary market, can get a higher return from the bond’s interest payments, as they may be higher than the bond’s coupon rate, giving the bond’s yield to maturity.
Coupon rate example
For example, a bond is issued with a par value of $1,000. It presupposes a coupon rate of 5 per cent and pays a total of $50 annually. Usually, if will be distributed at two semi-annual coupon payments of $25 each.
Note that not all bonds presuppose coupon payments. There are zero-coupon bonds for which coupon rate is 0 per cent. Such bonds will give holders only one payment of their face value on the maturity date. To compensate the bond holder, the zero-coupon bond’s price is usually less than its face value at any date before the maturity. This difference makes the purchase of the bond worthwhile.