The beauty of a fixed-income security is that an investor can expect to receive a certain amount of cash, provided, of course, that the bond or debt instrument is held until maturity (and its issuer does not default).
Most bonds pay interest semi-annually, which means bondholders receive two payments each year. So with a $1,000 face value bond that has a 10% semi-annual coupon, you would receive $50 (5% x $1,000) twice per year for the next 10 years. Bonds pay out simple interest (i.e., with no compounding), so the holder of such a bond could expect to receive a total of $1,000 in interest at expiration, and also receive the initial $1,000 principal amount paid for the bond back.
If interest rates change over the course of holding the bond, its market price of the bond will change, but you will still receive a fixed $50 coupon payment twice a year—and you will still get the full $1,000 back at maturity.
- Fixed-rate corporate or government bonds pay regular interest payments to bondholders.
- These bonds typically pay out a semi-annual coupon.
- Owning a 10% ten-year bond with a face value of $1,000 would yield an additional $1,000 in total interest through to maturity.
- If interest rates change, the price of the bond will fluctuate above or below $1,000, but the $100 per year of interest will remain the same.
If I Buy A $1,000 10-Year Bond With A 10% Coupon, Will I Receive $100 Each Year?
Bond Yield Concerns
While this calculation is accurate, most fixed-income investors, however, are concerned not with the coupon payment, but with the bond yield, which is a measure of the income generated by a bond, calculated as the interest divided by the price.
If the bond is selling at a face value of $1,000, or par, the coupon payment is equal to the yield, which in this case is 10%. This would also imply that prevailing interest rates are also right around 10%. But, bond prices are affected by (among other things) the interest offered by other income-producing bonds which make up the interest rate environment. As such, bond prices fluctuate as interest rates change, and in turn, so do bond yields.
To further illustrate the difference between yield and coupon payments, let's consider the $1,000 bond with a 10% coupon and its 10% yield ($100 / $1,000). Now, if the market price fluctuated and valued your bond to be worth $800, the bond's yield would now be 12.5% ($100 / $800), but the $50 semi-annual coupon payments would not change.
Conversely, if the bond price were to shoot up to $1,250, its yield would decrease to 8% ($100 / $1,250), but again, you would still receive the same $50 semi-annual coupon payments.
This is because a fixed-rate bond will always pay its stated coupon rate based on its face value at issuance. Thus, if you can earn 10% on the bond, but interest rates are now only 8%, the bond's payments become more attractive and the price of the bond is bid up accordingly. Likewise, if rates rise to 12%, the 10% coupon becomes less attractive and people will only buy that bond for a discount. This is why bond prices in the market and interest rates are inversely correlated.