A:

A bond's coupon rate has a large effect on its market price because it dictates the amount of income the bond generates per year. The coupon rate is the bond's annual interest rate, sometimes simply called its coupon. This rate is expressed as a percentage of the bond's par, or face value, which is generally $100 or $1,000. For example, a $1,000 bond that generates two interest payments of $25 each year has a coupon rate of $25 * 2 / $1,000, or 5%.

Coupon rates are largely influenced by the national interest rates controlled by the government. This means that if the minimum interest rate is set at 6%, no new bonds may be issued with coupon rates below this level. However, pre-existing bonds with coupon rates higher or lower than 6%, such as the one in the above example, can still be bought and sold on the secondary market.

Most bonds have fixed coupon rates, meaning that no matter what the national interest rate may be or how much the bond's market price fluctuates, the annual coupon payments remain stable. When new bonds are issued with higher interest rates, they are automatically more valuable to investors because they pay more interest per year compared to pre-existing bonds. Given the choice between two $1,000 bonds selling at the same price, one that pays 6% and one that pays 4%, the former is clearly the wiser option.

When interest rates rise, the value of existing bonds is decreased relative to newly issued bonds. To compensate for their diminished value, the market price of bonds with lower coupon rates is decreased. Conversely, when interest rates go down, the market price of pre-existing bonds with higher coupon rates goes up.

Because each bond returns its full par value to the bondholder upon maturity, investors can increase bonds' total yield by purchasing them at below-par prices, called discount. A $1,000 bond purchased for $800 generates coupon payments each year but also yields a $200 profit upon maturity, unlike a bond purchased at par.

RELATED FAQS
  1. What is the most common solvency ratios used in fundamental analysis?

    Learn about the difference between a bond's coupon rate and its yield rate, how the coupon rate influences market price and ... Read Answer >>
  2. How do debit spreads impact the trading of options?

    Find out what it means when a bond has a coupon rate of zero and how a bond's coupon rate and par value affect its selling ... 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. How do interest rates affect a bond's coupon rate?

    Find out how the changes in the national interest rate affect the coupon rates of newly issued bonds and why coupon rates ... Read Answer >>
  5. Can the marginal propensity to consume ever be negative?

    Find out when a bond's yield to maturity is equal to its coupon rate, and learn about the basic components of bonds and how ... Read Answer >>
  6. What are the key factors that will cause a bond to trade as a premium bond?

    Learn about the primary factor that can cause bonds to trade at a premium, including how national interest rates affect bond ... Read Answer >>
Related Articles
  1. 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.
  2. Investing

    Explaining the Coupon Rate

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

    What is a "Coupon"?

    In the financial world, “coupon” represents the interest rate on a bond.
  4. Financial Advisor

    Using Excel PV Function to compute Bonds PV

    To determine the value of a bond today - for a fixed principal (par value) to be repaid in the future at any predetermined time - we can use an Excel spreadsheet.
  5. Investing

    Understanding Bond Prices and Yields

    Understanding this relationship can help an investor in any market.
  6. Investing

    What is a Premium Bond?

    A premium bond is one that trades above its face or nominal amount.
  7. Investing

    Risks To Consider Before Investing In Bonds

    Make sure you understand the risks associated with bonds before making an investment decision.
  8. Financial Advisor

    Simple Math for Fixed-Coupon Corporate Bonds

    A guide to help to understand the simple math behind fixed-coupon corporate bonds.
RELATED TERMS
  1. Coupon Rate

    The yield paid by a fixed income security. A fixed income security's ...
  2. Coupon Bond

    A debt obligation with coupons attached that represent semiannual ...
  3. Current Coupon Bond

    A bond with a coupon rate that is within 0.5\% of the current ...
  4. Bond Valuation

    Bond valuation is a technique for determining the theoretical ...
  5. Bond

    A bond is a fixed income investment in which an investor loans ...
  6. Coupon

    The annual interest rate paid on a bond, expressed as a percentage ...
Hot Definitions
  1. Retirement Planning

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

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

    A transaction that can cancel out a forward contract that has the same value date.
  4. 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 ...
  5. Solvency

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

    A reduction in the ownership percentage of a share of stock caused by the issuance of new stock. Dilution can also occur ...
Trading Center