What Is a Bond Coupon?
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).
It is also referred to as the "coupon rate," "coupon percent rate", and "nominal yield."
Key Takeaways
- A coupon payment refers to the annual interest paid on a bond.
- Coupons are expressed as s a percentage of the face value and are paid from the issue date until maturity.
- The coupon rate is determined by adding the sum of all coupons paid per year, then dividing that total by the face value of the bond.
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Understanding Bond Coupons
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 current yield is used to calculate other metrics, such as the yield to maturity and the yield to worst.
Other Considerations
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.
