Coupon (Bonds) - Explained
What is a Bond Coupon?
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What is a Coupon Payment?
A coupon is mostly utilized in a bond or a note issued by the U.S Treasury Department or by corporate firms. It primarily refers to the annual interest rate that is paid on a bond and expressed as a percentage of the bonds face value. Coupons can take different names like coupon rate, coupon percentage rate, and mostly nominal yield.
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How Does a Bond Coupon Work?
A coupon is the amount an investor receives for each acquired bond depending on the percentage initially associated with it. For instance, a bond with a face value of $5000 at 4% interest yield per annum will pay a coupon of $200 yearly and $100 per coupon payment since it is done semi-annually. The ability to trade bonds before they mature makes the existing yield of a bond different from the nominal yield or the bonds coupon. This is usually due to market fluctuation. For instance, our $5000 defined above yield 4%, which is its normal nominal yield when the bond was issued. However, if the bond later trades for say $4500, its current yield will rise to 4.4% ($200 / $900). However, this new yield wont reflect on the coupon rate, as the investor will keep getting his $200 annual coupon payment. In a case where the face value increases to $5500, the current yield will fall to 3.6%, but will not be reflected in the coupon payments. Mathematically, Coupon rate = annual payments / the bonds face value Current yield = annual payments / the bonds market value Annual payments and the face value are usually constant and doesn't change. The current yield is utilized in the calculation of other metrics like the yield to maturity and the yield to worst.
Coupon in bonds refers to strippable coupons which are joined to bond certificates. Another name for bond with coupon is bearer bonds. These bonds are usually not registered, thus, merely having access to them constitute ownership. In order to cash out a coupon, the investor simply has to present the physical bond and no additional certificate or paperwork. Bearer bonds were popular in the old days, and sometime are used nowadays. However, most investors prefer not to used them as well as bond issuers. The reasons for this action are stated below:
- Damaged, stolen, or lost bonds usually become non-existent as there is no information whatsoever to claim that the investor purchased a bond, thus leading to loss of his capital
- Money launderers have misused its anonymity system
In a 1982 U.S. law, the use of Bearer bonds was prohibited for new bonds, and currently, all bearer bonds have passed their maturity date. Nowadays, investors and issuers prefer keeping electronic details and records on bond ownership. The term coupon, which was initially associated with bearer bond has managed to stand the test of time and even substitute for nominal yield.