Definition: Coupon rate is the stated interest rate on a fixed income security like a bond. In other words, it’s the rate of interest that bondholders receive from their investment. It’s based on the yield as of the day the bond is issued.
What Does Coupon Rate Mean?
The reason it’s called a coupon rate is that before electronic investing each bond was issued with pieces of paper called coupons. These were used to redeem each month’s interest payment from the bond issuer. Thus the interest rate on these pieces of paper was called the coupon rate.
This rate is the amount of interest the bondholder receives based on the bond’s nominal value.
Fixed rate bonds pay a fixed interest rate, which does not change once set at the issuance date, taking into account the interest rates at that time.
Variable rate bonds pay a variable interest rate, often equal to the LIBOR plus a quoted margin. The payment frequency varies from version to version.
For example, the rate of a government bond is usually paid once a year, but if it is a U.S. bond the payment is made twice a year. Other bonds may pay interest every three months.
In order to calculate the coupon rate formula of a bond, we need to know: the face value of the bond, the annual coupon rate, and the number of periods per annum.
Let’s look at an example.
Example
Georgia has a 10-year bond of company XYZ with a nominal value of $1,000 and a 20-year maturity. The rate pays 8% annually. The coupon’s current yield is 5.22%, and the yield to maturity is 3.85%. What is the coupon payment Georgia will receive?
The coupon payment on each bond is $1,000 x 8% = $80. So, Georgia will receive $80 interest payment as a bondholder. In fact, Georgia receives the coupon payment which is calculated at the bond’s interest rate, and not at the bond’s current yield or yield to maturity.
What will Georgia receive at maturity?
At maturity, in 20 years, Georgia will receive the nominal value of the bond $1,000 plus the coupon rate.
