Stated Interest

Definition

Stated interest is the nominal interest rate that is specified on a bond's face value, indicating the amount of interest that will be paid to bondholders. This rate is essential because it determines the cash flows received by investors, and it influences the bond's market price. The stated interest does not account for any premium or discount that may affect the actual yield an investor receives.

5 Must Know Facts For Your Next Test

1. The stated interest is typically fixed and does not change over the life of the bond, which means investors can predict their cash flows.
2. Stated interest is crucial for determining the bond's coupon payments, which are made to bondholders periodically, usually semi-annually or annually.
3. When market interest rates rise above the stated interest, existing bonds may sell at a discount, as investors seek higher yields elsewhere.
4. The stated interest affects both the attractiveness of a bond to investors and its pricing in the secondary market.
5. Investors should consider the stated interest alongside other factors like market conditions and the issuer's credit risk when evaluating bonds.

Review Questions

• How does stated interest impact the cash flows received by investors in bonds?
  • Stated interest directly determines the coupon payments that bondholders receive. Since this rate is fixed, it provides a predictable stream of income throughout the life of the bond. Investors can calculate their expected returns based on this rate, allowing them to assess the attractiveness of a bond relative to other investment opportunities.
• Discuss how changes in market interest rates influence the market price of bonds with a fixed stated interest rate.
  • When market interest rates rise above a bond's stated interest rate, the bond may trade at a discount because new issues offer higher yields. Conversely, if market rates fall below the stated interest rate, existing bonds become more attractive and may trade at a premium. This inverse relationship highlights how fluctuations in market rates affect investor demand and pricing dynamics in the bond market.
• Evaluate how understanding stated interest can assist investors in making informed decisions about bond investments.
  • Understanding stated interest helps investors assess potential returns and risks associated with bonds. By comparing stated interest rates with current market conditions and yields, investors can make better choices about which bonds to purchase or sell. Additionally, recognizing how factors like credit risk and inflation expectations interact with stated interest allows investors to evaluate overall investment strategies and align them with their financial goals.

Related terms

Coupon Rate: The annual interest rate paid on a bond's face value, typically expressed as a percentage.

Bond Discount: The situation when a bond is sold for less than its face value, often due to a lower stated interest rate compared to current market rates.

Yield to Maturity (YTM): The total return anticipated on a bond if it is held until it matures, taking into account the stated interest, purchase price, and time remaining until maturity.