Difference between interest rate and coupon rate of a bond

Stock Market
  1. Relationship Between Interest Rate & Bond Prices
  2. Financial assets
  3. Bond Coupon Interest Rate: How It Affects Price

The term technically applies to any financial product as long as it makes regular, fixed payments against a face value.

However, since bonds are the most common guaranteed-income securities, coupon rate most often applies to bonds. The coupon rate is the annual rate at which the bond repays its holder. It is not based on subsequent trading.


Relationship Between Interest Rate & Bond Prices

A bond coupon rate is a fixed payment, meaning that it will remain the same for the lifetime of the bond. That active payment occurs on a fixed basis, usually twice a year. Historically, when investors purchased a bond they would receive a sheet of paper coupons. The investor would return these coupons on a regular basis and receive their payment in exchange.

Today most issuers make payments electronically. This is the portion of its value that it repays investors every year.

Secondly, a bond coupon is often expressed in a dollar amount. It is what the bond is worth to its current holder. When the current holder is the initial purchaser of the bond, coupon rate and yield rate are the same.

Interest Rates

Once a bond is issued, investors may trade it over the course of its lifetime. Market conditions, coupon rate, and the issuing institution can all influence the aftermarket sale price of bonds. For example, in a scenario where experts are predicting economic inflation, the market interest rate for the bond may rise due to the fact that investors will expect more cash to offset the decrease in the value of the currency at large. Generally speaking, if a market interest rate exceeds a coupon rate, the value of the bond will likely drop.

Once a bond issuer has set a coupon rate and a face value, the bond issuer logically wishes to obtain the highest possible market price for the bond issue.

Financial assets

Typically, private companies will hire an investment bank to underwrite the bond issue. The investment bank, or syndicate of multiple investment banks, will purchase the entire bond issue and resell the bonds to large-scale and institutional investors on the open market. Many governmental entities, such as the United States Treasury, will sell bonds directly to large-scale investors through auctions rather than using an underwriter as a middleman.

The amount paid by investors for a bond, whether purchased through a direct auction, an underwriter or from another investor is the bond's market price. When the market price is less than face value, then the market rate, or yield, of that bond will be greater than the coupon rate.

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When the market price is greater than face value, then the market yield of that bond will be less than the coupon rate. Therefore, the relationship of the coupon rate and the market yield depends upon the market price of the bond.

Bond Coupon Interest Rate: How It Affects Price

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