Coupon Rate

What Is a Coupon Rate?

A coupon rate is the nominal yield paid by a fixed-income security. It is the annual coupon payments paid by the issuer relative to the bond's face or par value.

Understanding Coupon Rates

The coupon rate, or coupon payment, is the nominal yield the bond is stated to pay on its issue date. This yield changes as the [value of the bond changes](/variable-rated-request bond), hence giving the bond's yield to maturity (YTM).

A bond's coupon rate can be calculated by separating the sum of the security's annual coupon payments and partitioning them by the bond's par value. For instance, 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 equivalent, bonds with higher coupon rates are more attractive for investors than those with lower coupon rates.

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 utilization of real coupons for periodic interest payment collections. When set at the issuance date, a bond's coupon rate stays unchanged and holders of the bond receive fixed interest payments at a predetermined time or frequency.

A bond issuer settles on the coupon rate in light of pervasive market interest rates, among others, at the hour of the issuance. Market interest rates change over the long haul and as they move lower or higher than a bond's coupon rate, the value of the bond increments or diminishes, separately.

Changing market interest rates influence bond investment results. Since a bond's coupon rate is fixed all through the bond's maturity, a bondholder is left with getting comparably lower interest payments when the market is offering a higher interest rate. A similarly unfortunate alternative is selling the bond for not exactly its face value at a loss. Hence, bonds with higher coupon rates give a margin of safety against rising market interest rates.

In the event that the market rate turns lower than a bond's coupon rate, holding the bond is profitable, as different investors might need to pay more than the face value for the bond's comparably higher coupon rate.

Special Considerations

At the point when investors buy a bond initially at face value and afterward hold the bond to maturity, the interest they earn on the bond depends on the coupon rate set forward at the issuance. For investors gaining the bond on the secondary market, contingent upon the prices they pay, the return they earn from the bond's interest payments might be higher or lower than the bond's coupon rate. This is the effective return called yield to maturity (YTM).

For instance, a bond with a par value of $100 yet traded at $90 gives the buyer a yield to maturity higher than the coupon rate. On the other hand, a bond with a par value of $100 yet traded at $110 gives the buyer a yield to maturity lower than the coupon rate.

Features

• At the point when a market ticks up and is better, the coupon holder will yield not exactly the overarching market conditions as the bond won't pay more, as its value was determined at issuance.
• The yield to maturity is the point at which a bond is purchased on the secondary market, and it's the difference in the bond's interest payments, which might be higher or lower than the bond's coupon rate when it was issued.
• A coupon rate is the nominal yield paid by a fixed-income security.

FAQ

What's the Difference Between Coupon Rate and YTM?

The coupon rate is the annual income an investor can hope to receive while holding a particular bond. It is fixed when the bond is issued and is calculated by separating the sum of the annual coupon payments by the par value. At the time it is purchased, a bond's yield to maturity and its coupon rate are something similar. The yield to maturity (YTM) is the percentage rate of return for a bond assuming that the investor holds the asset until its maturity date. All it is the sum of its leftover coupon payments and will differ contingent upon its market value and the number of payments that still need to be made.

How Are Coupon Rates Affected by Market Interest Rates?

A bond issuer settles on the coupon rate in view of common market interest rates, among others, at the hour of the issuance. Market interest rates change after some time and as they move lower or higher than a bond's coupon rate, the value of the bond increments or diminishes, individually. Since a bond's coupon rate is fixed all through the bond's maturity, bonds with higher coupon rates give a margin of safety against rising market interest rates.

What Is the Effective Yield?

The effective yield is the return on a bond that has its coupon payments reinvested at a similar rate by the bondholder. It is the total yield an investor receives, rather than the nominal yield — which is the coupon rate. Basically, effective yield considers the power of compounding on investment returns, while nominal yield doesn't.