What Is Cum Coupon?
The term "cum coupon" is used in the secondary market for bonds, which is the market in which investors buy and sell bonds from one another as opposed to buying those bonds directly from the issuer. It signifies that the bond being purchased will include the current coupon payment as part of the purchase price. By contrast, a bond trading ex-coupon will not include the current coupon payment.
Because bonds trading cum coupon allow the new owner to collect an additional interest payment in the near future, cum coupon bonds generally command a higher price than those sold on an ex-coupon basis.
- Cum coupon refers to the practice of selling a bond whereby the new buyer is entitled to the upcoming coupon payment.
- Ex-coupon, in which the new buyer is not entitled to the upcoming coupon payment, is the opposite of cum coupon.
- Cum coupon is the conventional way of quoting bond prices in the United States, whereas ex-coupon is the conventional way in Europe.
- Both cum coupon and ex-coupon refer to bonds sold in the secondary market.
Understanding Cum Coupon
In the United States, cum coupon is the typical method for pricing bonds in the secondary market. In Europe, however, most bonds are priced on an ex-coupon basis. This distinction is important for investors to be aware of, so they don't accidentally overpay for a bond. An investor hailing from a country that uses the cum coupon convention for pricing bonds might accidentally overpay for a bond because they incorrectly assume they will receive the upcoming interest payment.
When valuing bonds, the price paid will be determined by several factors. These include the creditworthiness of the borrower, the opportunity cost presented by alternative investments, the timing of the next coupon payment, and the size of that coupon relative to market interest rates.
All else being equal, bond prices move inversely to interest rates, meaning a given bond will see its price rise as rates decline or fall as rates increase. Likewise, investors will generally pay a premium for bonds issued by creditworthy companies.
Prices will also be affected by how much time remains until the next coupon payment is due. Because of the time value of money, investors are willing to pay slightly more for a bond that is closer to its next coupon payment, provided that bond trades on a cum coupon basis.
When selling bonds, the original issuer will provide a prospectus specifying the bond's maturity date and payment schedule, which may involve coupon payments on an annual, semi-annual, quarterly, or even monthly basis.
Example of Cum Coupon
To illustrate cum coupon, consider a hypothetical 10-year bond with a face value of $10,000. The bond carries a 4% coupon and is issued on January 1. If the payment schedule is quarterly, there would be 40 coupons attached to the bond over of its 10-year term. Although interest continuously accrues, the first quarterly coupon would be paid on April 1, the second would be paid on June 1, and so on.
If one of these bonds is sold on the secondary market between April 1 and June 1, then the price would be adjusted depending on whether the new buyer receives payment for that June 1 coupon. If they do, the bond would trade cum coupon. The extent of the price adjustment would depend on factors such as the market rates of interest at the time, and the overall supply and demand situation for comparable bonds in the marketplace.