The coupon rate is the yield that a bond pays annually. The coupon rate is calculated as the sum of all periodic interest payments made on a bond divided by the face value of that bond. The coupon rate will typically be lower than the stated interest rate, which is also referred to as a nominal interest rate or nominal yield.
What is the coupon rate? – Definition
The coupon rate is the annual interest rate that a bond pays. That may seem obvious, but it’s important to remember: The coupon rate doesn’t specify how much you’ll receive each month, or even on the same day every year. It’s simply the total amount of interest paid over time, divided by how many years are left until your bond matures.
So when someone says “the 10-year Treasury has a 3% coupon,” what they really mean is that if you buy one of those bonds today and hold onto it for 10 years (or until maturity), then by then you’ll have made $30 in total interest payments back from the government. That’s because there are 30 full years left until that specific bond reaches its maturity date in 2028 and pays off its face valueāso $30 over 30 years will equal exactly 1% per annum compounded annually.
How to calculate the coupon rate? – Formula
The coupon rate is the percentage of an issued security’s face value that is paid out as interest by the issuer. The formula for calculating a bond’s coupon rate is:
\text {Coupon Rate} = \frac {\text {Coupon Payments}} {\text {Face Value}}The coupon rate is often expressed as a percentage, but it can also be expressed in decimal form.
The relationship between coupon rates and market interest rates
The coupon rate is a discount on the market interest rate, so it’s usually lower than what you’d receive for a personal loan or mortgage. This means that when you invest in these bonds, you’ll pay less interest overallāthat’s why this type of bond is called an “investment” bond instead of just a “borrowing” bond.
The coupon rate also helps to protect investors from inflation because these bonds can be redeemed at any time at their face value (the purchase price). What this means is that if inflation increases while your investment matures, its value will be affected less than other investments because it doesn’t rely on market fluctuations or stock prices.
FAQ
Is the coupon rate the same as the interest rate?
The coupon rate can be considered as the yield on a fixed-income security. The interest rate is the rate charged by the lender to the borrower for the borrowed amount.
How do you calculate the coupon rate?
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 āpar valueā) of the bond.
What does a higher coupon rate mean?
If a coupon is higher than the prevailing interest rate, the bond’s price rises; if the coupon is lower, the bond’s price falls.
