A Coupon Payment on a bond is a periodic interest payment that the bondholder receives during the time between when the bond is issued and when it matures.
Coupons are normally described in terms of the coupon rate, which is calculated by adding the total amount of coupons paid per year and dividing by the bond’s face value. For example, if a bond has a face value of $1,000 and a coupon rate of 5%, then it pays total coupons of $50 per year. For the typical bond, this will consist of semi-annual payments of $25 each.
The coupon rate is the yield that the bond pays on its issue date; however, this yield can change as the value of the bond changes and thus giving the bond’s yield to maturity. Bonds having higher coupon rates are therefore more desirable for investors than those having lower coupon rates.
The origin of the term “coupon” is that bonds were historically issued in the form of bearer certificates. Physical possession of the certificate was proof of ownership. Several coupons, one for each scheduled interest payment over the life of the bond, were printed on the certificate. At the date the coupon was due, the owner would detach the coupon and present it for payment (an act called “clipping the coupon”).
Not all bonds have coupons. Zero-coupon bonds are those that pay no coupons and thus have a coupon rate of 0%. Such bonds make only one payment: the payment of the face value on the maturity date. Normally, to compensate the bondholder for the time value of money, the price of a zero-coupon bond will always be less than its face value on any date before the maturity date. During the European sovereign-debt crisis, some zero-coupon sovereign bonds traded above their face value as investors were willing to pay a premium for the perceived safehaven status these investments hold. The difference between the price and the face value provides the bondholder with the positive return that makes purchasing the bond worthwhile.
Between a bond’s issue date and its maturity date (also called its redemption date), the bond’s price is determined by taking into account several factors, including:
- The face value;
- The maturity date;
- The coupon rate and frequency of coupon payments;
- The creditworthiness of the issuer; and
- The yield on comparable investment options.