A coupon rate is the yield paid by a fixed-income security; a fixed-income security's coupon rate is simply just the annual coupon payments paid by the issuer relative to the bond's face or par value. The coupon rate, or coupon payment, is the yield the bond paid on its issue date. This yield changes as the value of the bond changes , thus giving the bond's yield to maturity.
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A bond's coupon rate can be calculated by dividing the sum of the security's annual coupon payments and dividing them by the bond's par value. All else held equal, bonds with higher coupon rates are more desirable for investors than those with lower coupon rates. The coupon rate is the interest rate paid on a bond by its issuer for the term of the security. The term "coupon" is derived from the historical use of actual coupons for periodic interest payment collections.
Once set at the issuance date, a bond's coupon rate remains unchanged and holders of the bond receive fixed interest payments at a predetermined time-frequency. A bond issuer decides on the coupon rate based on prevalent market interest rates, among others, at the time of the issuance. Market interest rates change over time and as they move higher or lower than a bond's coupon rate, the value of the bond increases or decreases, respectively. Changing market interest rates affect bond investment results. Since a bond's coupon rate is fixed all through the bond's maturity, a bondholder is stuck with receiving comparably lower interest payments when the market is offering a higher interest rate.
An equally undesirable alternative is selling the bond for less than its face value at a loss. Thus, bonds with higher coupon rates provide a margin of safety against rising market interest rates. If the market rate turns lower than a bond's coupon rate, holding the bond is advantageous, as other investors may want to pay more than the face value for the bond's comparably higher coupon rate.
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When investors buy a bond initially at face value and then hold the bond to maturity, the interest they earn on the bond is based on the coupon rate set forth at the issuance. For investors acquiring the bond on the secondary market, depending on the prices they pay, the return they earn from the bond's interest payments may be higher or lower than the bond's coupon rate.
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This is the effective return called yield to maturity. For related reading, see " Yield to Maturity vs.
Coupon Rate: What's the Difference? Fixed Income Essentials. Corporate Bonds.
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Company ABC issued a bond of Rs. Following are the details of the issue:.
What is Coupon Rate Formula?
Tata Capital Financial Services Ltd. Issued secured and unsecured NCDs in Sept Details of the issue are as following:. As we know, an investor expects a higher return for investing in a higher risk asset. Coupon Rate of a bond is determined after considering various factors, but two of the key factors are interest rates of different fixed income security available in market at the time of issue of bond and creditworthiness of the company.
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The coupon rate of a bond is determined in a manner so that it remains competitive with other available fixed income securities. However, the coupon rate of newly issued fixed income securities may increase or decrease during the tenure of a bond based on market conditions, which results in the change in the market value of a bond. Market Value of a bond is a derivation of difference in coupon rate of bond and market interest rate of other fixed income securities.
If interest rate of a bond is below the market interest rate, the bond is said to be traded at discount, while if the interest rate of bond is higher than market interest rate, the bond is said to be traded at premium and similarly, a bond is said to be traded at par if interest rate of bond is equal to market interest rate.
The coupon rate is also depended on the creditworthiness of the company. Companies need to undertake credit rating of the bond from a credit rating agency before issuing of the bond. Credit rating agencies assign a credit rating to the bond issue after assessing the issuer on various parameters riskiness of the business in which company operates, financial stability, legal history, default history, ability to repay money borrowed through bond etc.
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Higher the rating of a bond means higher safety and hence lower coupon rate and vice versa. Coupon Rate Formula helps in calculating and comparing the coupon rate of differently fixed income securities and helps to choose the best as per the requirement of an investor. It also helps in assessing the cycle of interest rate and expected market value of a bond, for eg. If market interest rates are declining, the market value of bonds with higher interest rates will increase, resulting in higher yield and hence higher return on investment and vice versa in increasing market interest rate scenario.
This has been a guide to Coupon Rate Formula. Here we discuss How to Calculate Coupon Rate along with practical examples.