Bonds are issued by governments and companies to raise money to finance their operations or for capital projects. When an investor buys a bond, the bond issuer promises periodic (annually or semi-annually) interest payments on the money invested at the coupon rate stated in the bond certificate.
A coupon rate is the yield paid by a fixed-income security; a fixed-income security’s coupon rate is simply just the annual coupon payments paid by the issuer relative to the bond’s face or par value. The coupon rate is the yield the bond paid on its issue date. This yield changes as the value of the bond changes, thus giving the bond’s yield to maturity.
The bond issuer pays interest annually until maturity, after which the issuer returns the principal amount (or face value).
The coupon rate of a bond is calculated on the bond’s face value (par value).
Example of how Coupon rates is determined:
If you own a 10 year – N100,000 bond with a coupon rate of 10%, you will receive interest payments of N10,000 every year for 10 years, no matter the changes in bond price in the market.
Note: Coupon rate is not the same as the rate of interest.
For example if you bought a bond of face value N1000 and the coupon rate is 10%, it means every year you will get N100 (10% of N1,000). However, if you bought the bond above its face value, let’s say N2,000, you will still get a coupon rate of 10% of N1,000(N100).
Since the bond was bought for N2,000, the rate of interest this time will be 5% (N100 of N2,000).