Coupon Rate

What it is

The coupon rate is the nominal annual interest rate a bond issuer promises to pay bondholders. It is expressed as a percentage of the bond’s par (face) value and determines the periodic cash interest payments received until the bond matures. Once set at issuance, the coupon rate does not change.

How it’s calculated

Coupon Rate = (Annual coupon payments / Par value) × 100

Example: A bond with $1,000 par value that pays $50 per year has a coupon rate of (50 / 1,000) × 100 = 5%.

If coupons are paid semiannually, add the two semiannual payments to get the annual total before applying the formula.

Coupon rate vs. yield

• Coupon rate: the fixed percentage of par that determines scheduled interest payments.
• Current yield: annual coupon payment divided by the bond’s current market price. It reflects income based on what you actually pay for the bond.
• Yield to maturity (YTM): the annualized return assuming you hold the bond to maturity and reinvest coupons at the same rate. YTM accounts for the bond’s market price, remaining payments, and any capital gain or loss at maturity.

When a bond trades at par, coupon rate = current yield = YTM. If it trades at a discount (below par), YTM > coupon rate; if it trades at a premium, YTM < coupon rate.

Example

A bond with $100 par and a 3% coupon pays $3 annually.
– If bought for $90, current yield = 3 / 90 = 3.33%.
– If bought for $110, current yield = 3 / 110 = 2.73%.
YTM will differ from these figures depending on remaining term and reinvestment assumptions.

How market interest rates affect coupon-bearing bonds

• Market rates rise above a bond’s coupon: the bond becomes less attractive; its market price falls so YTM increases toward prevailing rates.
• Market rates fall below a bond’s coupon: the bond becomes more attractive; its market price rises and may trade above par.

Because the coupon is fixed, bonds with higher coupon rates are generally less sensitive to rising market rates and provide greater income relative to low-coupon bonds.

Effective yield (realized yield)

Effective yield (or effective annual yield) reflects compounding when coupon payments are reinvested at the same rate. It is typically higher than the nominal coupon rate when compounding is taken into account. YTM incorporates the effect of price changes and remaining payments; effective yield focuses on compounding of coupon reinvestment.

Simple explanation

Think of the coupon as a yearly interest check. The coupon rate tells you what percentage of the bond’s face value that check equals. If you buy the bond for more or less than face value, your actual income relative to the price you paid (current yield) will differ from the coupon rate.

Key takeaways

• The coupon rate is the fixed annual interest percentage of a bond’s par value.
• It determines scheduled interest payments but not the bond’s market return after purchase.
• Market interest rates drive bond prices; a fixed coupon means yields move inversely to price.
• For investors buying in the secondary market, compare coupon rate, current yield, and YTM to understand expected returns.