Coupon Rate is referred to the stated rate of interest on fixed income securities such as bonds. It is the periodic rate of interest paid on the bond’s face value to its purchasers. It is to be noted that the coupon rate is calculated based on the bond’s face value or par value.
Table of contents
- What is a Coupon Rate?
- What is Coupon Rate? Definition of Coupon Rate, Coupon Rate Meaning - The Economic Times
- Understanding the Coupon Rate
Coupon Rate is referred to the stated rate of interest on fixed income securities such as bonds. In other words, it is the rate of interest that the bond issuers pay to the bondholders for their investment. Therefore, the rate of a bond can also be seen as the amount of interest paid per year as a percentage of the face value or par value of the bond.
Mathematically, it is represented as,. The bond price varies based on the coupon rate and the prevailing market rate of interest. If the coupon rate is lower than the market interest rate, then the bond is said to be traded at discount, while the bond is said to be traded at a premium if the coupon rate is higher than the market interest rate. Nevertheless, the bond is said to be traded at par if the coupon rate is equal to the market interest rate. Let us take the example of a bond with quarterly coupon payments.
When a bond is issued in the open market by a company, it arrives at the optimal coupon rate based on the prevailing rate of interest in the market to make it competitive.
What is a Coupon Rate?
It is quintessential to grasp the concept of the rate because almost all types of bonds pay annual interest to the bondholder, which is known as the coupon rate. Unlike other financial metrics, the coupon payment in terms of the dollar is fixed over the life of the bond. Another important facet of the rate is that if the prevailing market interest rate is higher than the rate of the bond, then the price of the bond is expected to fall because an investor will be reluctant to purchase the bond at that face value now, as they can get a better rate of return elsewhere.
On the other hand, if the prevailing market interest rate is lower than the coupon rate of the bond, then the price of the bond is expected to increase because it will pay a higher return on investment than an investor can make by purchasing a similar bond now, as the coupon rate will be lower resulting the in overall decline in interest rates. This has been a guide to what is Coupon Rate of a Bond and its definition.
Here we discuss how to calculate Coupon Rate along with its formula, examples, and relevance.
What is Coupon Rate? Definition of Coupon Rate, Coupon Rate Meaning - The Economic Times
You can learn more about from the following articles —. The term yield is used to describe the return on your investment as a percentage of your original investment. Yield is the ratio of annual dividends divided by the share price. The yield can be calculated based on dividends paid over the past year or dividend expectations for the next.
Understanding the Coupon Rate
In the case of a bond, the yield refers to the annual return on an investment. The yield on a bond is based on both the purchase price of the bond and the interest promised — also known as the coupon payment. As a result, after bonds are issued, they trade at premiums or discounts to their face values until they mature and return to full face value.
Now the price of the bond drops in the market to Rs Later, the price of the bond rises to Rs 1, Because yield is a function of price, changes in price result in bond yields moving in the opposite direction. There are two ways of looking at bond yields - current yield and yield to maturity. This is is the annual return earned on the price paid for a bond. It is calculated by dividing the bond's coupon rate by its purchase price.
The interest earned would be Rs 60 in a year.
When a bond is purchased at face value, the current yield is the same as the coupon rate. The current yield would be 6. This reflects the total return an investor receives by holding the bond until it matures. Taking the above example and using the formula, the YTM would be calculated as follows:. Membership Login My Profile Register. Equities Equities Home Stocks Quickrank. Company Site.
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