DEFINITION of Short Coupon
A short coupon is a payment made on a bond within a shorter time interval than is normal for the bond. Most often, a short coupon is a bond's first coupon. A short coupon is used if the issuer wishes to make payments on certain dates, for example, June 30 and December 31, rather than simply after a particular interval from when it is sold in the primary market.
BREAKING DOWN Short Coupon
In the U.S., coupon payments are commonly made semi-annually, that is, every six months. A short coupon refers to interest payments on a bond for a period that is shorter than the standard six months. These payments usually apply to the first coupon payment after a bond’s issuance. Subsequent payments after the first interest payment are distributed following the normal semi-annual cycle. For example, assume a 5-year bond was issued on March 15, 2017. The bond is to pay coupons twice a year on May 15 and November 15, every year until it matures. Its first payment date is scheduled for May 15, 2017. On this date, the investor will receive interest that has accrued from the issuance date to the payment date, that is, from March 15 to May 15, which is less than six months. In fact, this interest payment covers only two months. However subsequent coupon payments will be paid normally and in full, following the conventional six-month period.
The short coupon is computed from the accrued interest payable from the issue date until the first coupon payment date. For the first interest installment, the investor will receive a coupon proportional to its maturity. Continuing with our example, above, assume the interest rate on the bond is 4% and the par value is $100,000. The day count between March 15 (issue date) and May 15 (coupon date) is 61. The six-month period or the reference period leading up to the payment date (November 15, 2016 to May 15, 2017) has 181 days. The coupon that will be paid on May 15 can be calculated as:
(61/181) x (0.04/2) x $100,000 = $674.03
In some countries, it is the norm to make coupon payments only once per year. The schedule by which coupon payments are made does not generally affect yields, since the price of a bond will quickly adjust such that the effective yield on any given issue is comparable to similar bonds in the market. However, unusual payment schedules, such as those in which no payment is made for several years, may require a higher effective yield to entice buyers.