Definition: The annual rate of interest that the company or government which issued the bond will pay on the amount it has borrowed (ie: the bond’s face value). The rate for an ordinary bond is printed on the bond and does not change for the life of the bond.
Example: In March of 2009, Coca-Cola issued a 4.875%, 10-year bond (ie, it matures in March of 2019). The coupon rate is 4.875%. To compute the dollar amount of annual interest Coca-Cola has to pay to the bondholder, we multiply the coupon-rate by the amount borrowed (ie, the bond’s face value): 4.875% * $1,000, or $48.75.
Investeach explains: Because both the coupon rate and the face value of the bond remain unchanged for the life of an ordinary bond, the annual interest the bond pays during its life also stays the same. This is critically important to companies because they know exactly how much interest they’ll have to pay out each year.
Yet, there are companies who are willing to take a risk and pay a rate of interest that is not fixed. If interest rates in the economy go up, they’re willing to pay more. If they fall, the companies will have the benefit of paying less interest. See floating rate bond.
Interest rates can move up and down over the years (and the rates offered by companies will have to reflect the level of rates that exist at the time a company wants to borrow money by issuing bonds). Yet, if we look at the coupon rate being offered by different companies and governments borrowing around the same time, we will see which ones are more risky than the others. For example, above we saw that in March of 2009, Coca-Cola was to get investors to lend is money by offering them 4.875% per year. If a less-established and profitable company wanted to borrow money in the same month, it might have to offer investors 7%, 8%, or higher to get them to take the greater risk.
Riddle me this:
1. What does it mean to express a number as a rate?
2. How do we compute the actual dollar amount a holder of a bond will be paid?
3. Over what period of time will the bondholder be paid this dollar amount?
4. How often does the coupon rate of an ordinary bond change over the life of the bond?
5. If a company believes that interest rates will fall, what type of bond can it issue to take advantage of this possibility?
Also known as: Nominal rate, Stated rate.