Definition: A coupon payment is the annual interest payment paid to a bondholder by the bond issuer until the debt instrument matures. In other words, there payments are the periodic payments of interest to the bondholders.
What Does Coupon Payment Mean?
What is the definition of coupon payment? Coupon payments are vital incentives to investors who are attracted to lower risk investments. These payments get their name from previous generations of bonds that had a physical, tear off coupon that investors had to physically hand in to the issuer as evidence that they owned the bond. It was also used as a way to track the steady payment stream to investors. You simply count the coupons to see how many payments have been made.
Let’s look at an example.
Example
Mark has just earned $10,000 through his work as a lifeguard during the summer. Now, he wants to invest his money in something safe, something that will allow him to make it grow, but also something where there is little risk of him losing his money. He decides to look into bonds, something that he has heard about periodically throughout his life. First, he looks at the US Treasury Bond, one of the safest, which returns 3% per year for 10 years. He also looks at a riskier corporate bond, which will return 15% per year for 5 years. However, Mark reads the news and sees that the company is on the brink of failure. Despite the attractive return, he decides to purchase $10,000 of the US Treasury Bond. Now, how will this affect his $10,000 principal?
Using the 3% rate of return on the bond, Mark calculates that the bond’s coupon payment formula, or annual payment to him, is ($10,000 x (0.03)) = $300, or $3,000 overall. While he now knows that the corporate bond would have paid him $1500 per year ($10,000 x (0.15)), or $7,500 overall, there was a high risk with that investment, and he is satisfied in a safe, secure $300 per year.
Twenty years later, Mark earns his last payment of $300, plus his original investment of $10,000. In total, Mark has turned his $10,000 into $13,000 over 10 years, which was a safe, and smart, investment for him.
Summary Definition
Define Coupon Payments: Coupon payment means the interest installment paid to bond holders.
