What is Coupon?
In bonds, a coupon refers to the periodic interest payment made to bondholders by the issuer of the bond. It represents the fixed or variable interest rate that the issuer promises to pay to bondholders over the life of the bond.
When a bond is issued, it typically has a stated coupon rate, which is expressed as a percentage of the bond's face value.
The coupon payments are usually made semi-annually or annually, although other payment frequencies are possible, depending on the terms of the bond. The bondholder receives these periodic interest payments until the bond's maturity date when the principal amount (face value) is repaid.
Why is Coupon important?
The coupon rate is an important factor in determining the yield or return that bondholders can expect to earn from holding the bond. It is typically set based on several factors, including prevailing market interest rates, the creditworthiness of the issuer, and the specific terms of the bond.
When market interest rates rise or fall, the coupon rate on newly issued bonds may be adjusted to align with the prevailing rates. Bonds with fixed coupon rates, however, continue to pay the same fixed interest rate over their life, regardless of changes in market interest rates. As a result, the yield of fixed-rate bonds may differ from prevailing market yields, impacting their attractiveness to investors.
It's worth noting that the term coupon originates from the historical practice of detachable coupons that bondholders would physically clip and present for payment. However, in modern bond trading, coupon payments are typically made electronically, and the term coupon refers to the interest payment itself.
Coupon payments are a significant component of the return on investment for bondholders and serve as a means for the issuer to compensate bondholders for lending money.