A:

A bond's coupon rate is equal to its yield to maturity if its purchase price is equal to its par value. The par value of a bond is its face value, or the stated value of the bond at the time of issuance, as determined by the issuing entity. Most bonds have par values of $100 or $1,000. The par value of a bond does not dictate its market price, however. Instead, the market, or selling, price of a bond is influenced by a number of factors in addition to its par. These factors include the bond's coupon rate, maturity date, prevailing interest rates and the availability of more lucrative bonds.

The coupon rate of a bond is its interest rate, or the amount of money it pays the bondholder each year, expressed as a percentage of its par value. A bond with a $1,000 par value and coupon rate of 5% pays $50 in interest each year until maturity.

A bond's maturity date is simply the date on which the bondholder receives repayment for his investment. At maturity, the issuing entity must pay the bondholder the par value of the bond, regardless of its current market value. This means that if an investor purchases a five-year $1,000 bond for $800, he collects $1,000 at the end of five years in addition to any coupon payments he received during that time.

The market value of bonds has a negative correlation with prevailing interest rates. As interest rates go up, the price of pre-existing bonds goes down. As rates decline, current bonds with higher rates become more valuable.

For example, if a company issues a $1,000 bond with a 4% interest rate, but the government subsequently raises the minimum interest rate to 5%, then any new bonds being issued have higher coupon payments than the company's initial 4% bond. To entice investors to purchase the bond despite its lower coupon payments, the company has to sell the bond at less than its par value, which is called a discount. If, instead, interest rates drop to 3%, the pre-existing 4% bond sells for more than its par value; this is called a premium.

Since the market price of bonds is so changeable, it is possible to make a profit in addition to that generated by coupon payments by purchasing bonds at a discount. The yield to maturity of a bond is the rate of return generated by a bond after accounting for its market price, expressed as a percentage of its par value. Considered a more accurate estimate of a bond's profitability than other yield calculations, the yield to maturity of a bond incorporates the gain or loss created by the difference between the bond's purchase price and its par value.

If a bond is purchased at par, therefore, then its yield to maturity is equal to its coupon rate, because the initial investment is offset entirely by repayment of the bond at maturity, leaving only the fixed coupon payments as profit. If a bond is purchased at a discount, then the yield to maturity is always higher than the coupon rate. If it is purchased at a premium, the yield to maturity is always lower.

RELATED FAQS
  1. What types of fees apply to checking accounts?

    Learn about the difference between a bond's coupon rate and its yield to maturity, and how the par value, coupon rate and ... Read Answer >>
  2. Will the price of a premium bond be higher or lower than its par value?

    Find out why the selling price of a premium bond is always higher than its par value, including how changing interest rates ... Read Answer >>
  3. How does the effective interest method treat the interest on a bond?

    Find out why you should look at the effective interest of a bond rather than simply relying on its stated coupon rate when ... Read Answer >>
  4. Should investors focus more on the current yield or face value of a bond?

    Find out when investors should focus on a bond's current yield versus its face value, including an example of how current ... Read Answer >>
  5. How does a bond's coupon interest rate affect its price?

    Find out why the difference between the coupon interest rate on a bond and prevailing market interest rates has a large impact ... Read Answer >>
Related Articles
  1. Investing

    Comparing Yield To Maturity And The Coupon Rate

    Investors base investing decisions and strategies on yield to maturity more so than coupon rates.
  2. Financial Advisor

    Simple Math for Fixed-Coupon Corporate Bonds

    A guide to help to understand the simple math behind fixed-coupon corporate bonds.
  3. Investing

    An Introduction to Individual Bonds

    Individual bonds are better than bond funds and can be a key component to one’s investment strategy.
  4. Investing

    How Does A Bond’s Coupon Interest Rate Affect Its Price?

    All bonds come with a coupon interest rate, which is the fixed annual interest a bond pays.
  5. Investing

    Risks To Consider Before Investing In Bonds

    Make sure you understand the risks associated with bonds before making an investment decision.
  6. Investing

    Explaining the Coupon Rate

    Coupon rate is the stated interest rate on a fixed income security.
  7. Investing

    If I Buy A $1,000 10-Year Bond With A 10% Coupon, Will I Receive $100 Each Year?

    Investors can count on a fixed-income security paying them a certain amount of cash as long as the security is held until maturity and the issuer doesn’t default.
  8. Investing

    Understanding the Different Types of Bond Yields

    Any investor, private or institutional, should be aware of the diverse types and calculations of bond yields before an actual investment.
RELATED TERMS
  1. Discount Bond

    A discount bond is a bond that is issued for less than its par ...
  2. At Par

    A term that refers to a bond, preferred stock or other debt obligation ...
  3. Below Par

    A term describing a bond whose price is below the face value ...
  4. Coupon

    The annual interest rate paid on a bond, expressed as a percentage ...
  5. Yield To Maturity (YTM)

    Yield to maturity (YTM) is the total return expected on a bond ...
  6. Current Coupon Bond

    A bond with a coupon rate that is within 0.5\% of the current ...
Hot Definitions
  1. Nostro Account

    A bank account held in a foreign country by a domestic bank, denominated in the currency of that country. Nostro accounts ...
  2. Retirement Planning

    Retirement planning is the process of determining retirement income goals and the actions and decisions necessary to achieve ...
  3. Drawdown

    The peak-to-trough decline during a specific record period of an investment, fund or commodity. A drawdown is usually quoted ...
  4. Inverse Transaction

    A transaction that can cancel out a forward contract that has the same value date.
  5. Redemption

    The return of an investor's principal in a fixed income security, such as a preferred stock or bond; or the sale of units ...
  6. Solvency

    The ability of a company to meet its long-term financial obligations. Solvency is essential to staying in business, but a ...
Trading Center