Coupon rate

Definition

The coupon rate is the annual interest rate paid by bond issuers to bondholders, expressed as a percentage of the bond's face value. This rate determines the periodic interest payments that bondholders receive, making it a crucial factor in bond valuation and investment decisions. The coupon rate influences the bond's market price, yield, and overall attractiveness compared to other investment opportunities.

5 Must Know Facts For Your Next Test

1. The coupon rate is typically fixed over the life of the bond, providing predictable income to investors.
2. When market interest rates rise, existing bonds with lower coupon rates may decrease in price since new bonds are issued with higher rates.
3. Coupon payments are usually made semiannually, although some bonds may offer annual or quarterly payments.
4. Investors often compare the coupon rate with the yield to maturity to assess whether a bond is a good investment.
5. A bond's coupon rate can affect its demand; higher rates tend to attract more investors seeking income.

Review Questions

• How does the coupon rate influence a bond's market price and investor behavior?
  • The coupon rate directly affects a bond's market price because it determines the interest income an investor will receive. When prevailing market interest rates rise above a bond's coupon rate, the bond becomes less attractive, leading to a decrease in its market price. Conversely, if market rates fall below the coupon rate, demand for that bond increases, driving up its price. This relationship showcases how investor behavior shifts based on interest rate changes and highlights the importance of evaluating a bond's coupon rate when making investment decisions.
• Evaluate the implications of different coupon rates for investors in terms of risk and return.
  • Different coupon rates present varying levels of risk and return for investors. Bonds with higher coupon rates often provide more attractive returns but may also carry higher credit risk if issued by less stable entities. Conversely, bonds with lower coupon rates are generally associated with lower risk, particularly if they are issued by highly rated entities. Investors must weigh these factors when selecting bonds, as they seek a balance between desired income and acceptable risk levels based on their investment goals.
• Synthesize how changes in interest rates can impact both new bond issuance and existing bonds' market values concerning their coupon rates.
  • When interest rates change, they significantly affect both new bond issuance and the market values of existing bonds in relation to their coupon rates. New bonds are typically issued at rates reflecting current market conditions, which means that when interest rates rise, new bonds will offer higher coupon rates. Existing bonds with lower coupon rates may decrease in value as investors seek higher returns elsewhere. This dynamic not only influences investor preferences but also affects overall market liquidity and pricing strategies for both new issuances and outstanding bonds.

Related terms

bond: A bond is a fixed-income investment that represents a loan made by an investor to a borrower, typically a corporation or government.

yield to maturity: Yield to maturity (YTM) is the total return anticipated on a bond if it is held until it matures, taking into account all coupon payments and the difference between the purchase price and face value.

face value: The face value is the nominal value of a bond that is repaid to the bondholder at maturity; it also serves as the basis for calculating coupon payments.