What Is a Coupon Rate?

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, or coupon payment, 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.

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Coupon Rate

How a Coupon Rate Works

A bond's coupon rate can be calculated by dividing the sum of the security's annual
coupon payments and dividing them by the bond's par value. For example, a bond
issued with a face value of $1,000 that pays a $25 coupon semiannually has a coupon
rate of 5%. All else held equal, bonds with higher coupon rates are more desirable
for investors than those with lower coupon rates.

The coupon rate is the interest rate paid on a bond by its issuer for the term of
the security. The term "coupon" is derived from the historical use of actual
coupons for periodic interest payment collections. Once set at the issuance date, a
bond's coupon rate remains unchanged and holders of the bond receive fixed interest
payments at a predetermined time-frequency.

KEY TAKEAWAYS
A coupon rate is the yield paid by a fixed-income security.
When a market ticks up and is more favorable, the coupon holder will yield less
than the prevailing market conditions as the bond will not pay more, as its value
was determined at issuance.
The yield to maturity is when a bond is purchased on the secondary market, and is
the difference in the bond's interest payments, which may be higher or lower than
the bond's coupon rate when it was issued.
A bond issuer decides on the coupon rate based on prevalent market interest rates,
among others, at the time of the issuance. Market interest rates change over time
and as they move higher or lower than a bond's coupon rate, the value of the bond
increases or decreases, respectively.

Special Considerations: Market Rate and Yield to Maturity

Changing market interest rates affect bond investment results. Since a bond's
coupon rate is fixed all through the bond's maturity, a bondholder is stuck with
receiving comparably lower interest payments when the market is offering a higher
interest rate. An equally undesirable alternative is selling the bond for less than
its face value at a loss. Thus, bonds with higher coupon rates provide a margin of
safety against rising market interest rates.

If the market rate turns lower than a bond's coupon rate, holding the bond is
advantageous, as other investors may want to pay more than the face value for the
bond's comparably higher coupon rate.
When investors buy a bond initially at face value and then hold the bond to
maturity, the interest they earn on the bond is based on the coupon rate set forth
at the issuance. For investors acquiring the bond on the secondary market,
depending on the prices they pay, the return they earn from the bond's interest
payments may be higher or lower than the bond's coupon rate. This is the effective
return called yield to maturity.

For example, a bond with a par value of $100 but traded at $90 gives the buyer a
yield to maturity higher than the coupon rate. Conversely, a bond with a par value
of $100 but traded at $110 gives the buyer a yield to maturity lower than the
coupon rate. (For related reading, see "Yield to Maturity vs. Coupon Rate: What's
the Difference?")

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Related Terms
Bond
A bond is a fixed income investment in which an investor loans money to an entity
(corporate or governmental) that borrows the funds for a defined period of time at
a fixed interest rate. more
Straight Bond
A straight bond is a bond that pays interest at regular intervals, and at maturity
pays back the principal that was originally invested. more
Current Coupon
A current coupon is a bond that pays a coupon consistent with its original face
value. more
Required Yield Definition
Required yield is the return that a bond must offer in order for the investment to
be worthwhile. more
Bond Discount
Bond discount is the amount by which the market price of a bond is lower than its
principal amount due at maturity. This amount, called its par value, is often
$1,000. more
Factors that Create Discount Bonds
A discount bond is one that issues for less than its par—or face—value, or a bond
that trades for less than its face value in the secondary market. more