Coupon Rate

Key Highlights

• The coupon rate is simply the yearly interest a bond issuer agrees to pay you for lending them money.

• Types of coupon rates includes fixed, floating and zero coupon.

What is Coupon Rate?

The coupon rate is simply the yearly interest a bond issuer agrees to pay you for lending them money. It’s a percentage of the bond’s face value (the amount you’ll get back when the bond matures). Think of it as the bond’s “interest paycheck” you receive regularly, usually every six months or yearly, until the bond matures.

Why It’s Important?

• Predictable Income: The coupon rate guarantees steady payments, perfect for those who want reliable income, like retirees.

• Market Impact: When interest rates in the market go up, your bond might lose value because newer bonds offer better returns. On the other hand, if market rates drop, your bond becomes more attractive, which can push its price up.

• Risk Factor: Riskier issuers (like companies with lower credit ratings) often offer higher coupon rates to attract buyers, while safer issuers (like governments) can offer lower rates.

Types of Coupon Rates

• Fixed Coupon: Most bonds have a fixed coupon rate that stays the same throughout the bond’s life, offering predictable payments.

• Floating Coupon: Some bonds have rates that adjust with market conditions, like tying to a benchmark (e.g., LIBOR). These are less predictable but can benefit from rising rates.

• Zero Coupon: These bonds pay no interest during their term. Instead, you buy them at a discount and get the face value at maturity, with the “interest” built into the price difference.

Factors Affecting Coupon Rates

• Issuer Credit Quality: Safer issuers (e.g., governments) offer lower rates; riskier ones (e.g., corporations) offer higher rates to attract buyers.

• Bond Duration: Longer-term bonds often have higher coupon rates to compensate for the risk of interest rate changes over time.