A bond's coupon is the annual interest rate paid on the issuer's borrowed money, generally paid out semiannually. The coupon is always tied to a bond's face or par value, and is quoted as a percentage of par. Many bond investors rely on a bond's coupon as a source of income, spending the simple interest they receive.
You can also reinvest the interest, letting your interest gain interest. If the interest rate at which you reinvest your coupons is higher or lower, your total return will be more or less. Also be aware that taxes can reduce your total return. Regardless of the type of investment you select, saving regularly and reinvesting your interest income can turn even modest amounts of money into sizable investments through the remarkable power of compounding. Accrued interest is the interest that adds up accrues each day between coupon payments.
If you sell a bond before it matures or buy a bond in the secondary market, you most likely will catch the bond between coupon payment dates. If you're selling, you're entitled to the price of the bond, plus the accrued interest that the bond has earned up to the sale date.
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The buyer compensates you for this portion of the coupon interest, which is generally handled by adding the amount to the contract price of the bond. Use our Accrued Interest Calculator to figure out a bond's accrued interest. But a bond's price is subject to market forces and often fluctuates above or below par. If you sell a bond before it matures, you may not receive the full principal amount of the bond and will not receive any remaining interest payments.
This is because a bond's price is not based on the par value of the bond. Instead, the bond's price is established in the secondary market and fluctuates. As a result, the price may be more or less than the amount of principal and the remaining interest the issuer would be required to pay you if you held the bond to maturity. If a bond trades above par, it is said to trade at a premium. If a bond trades below par, it is said to trade at a discount.
Types of Bonds
For example, if the bond you desire to purchase has a fixed interest rate of 8 percent, and similar-quality new bonds available for sale have a fixed interest rate of 5 percent, you will likely pay more than the par amount of the bond that you intend to purchase, because you will receive more interest income than the current interest rate 5 percent being attached to similar bonds. Learn more about our updates. Give Us Feedback. Create your own user feedback survey. Bond Basics. What's a Bond? Callable Bonds Not all bonds reach maturity, even if you want them to. The holder of these bonds buys them at a substantially lower price than the par value i.
Introduction to Zero-Coupon Municipal Bonds
Another security that has a unique coupon structure is step-up bonds. These are bonds that have a coupon rate that increases over time. For example, a 5-year step-up bond of the par value of USD Thus the coupon payment looks as follows —. In the floating-rate securities, the coupon rate need not be fixed over the life of the security.
These securities have coupons that are tied to a reference rate, and the coupons are reset periodically according to changes in the reference rate. The quoted margin is the additional amount that the issuer agrees to pay over the reference rate. For example, suppose the reference rate is 5-year Treasury Yield and the quoted margin is 0.
Now if this coupon is revised every six months and after six months the 5-Year Treasury Yield is 6. The coupon rates of such floating-rate securities come with a floor and a cap, which means the rate cannot decrease below the floor and it cannot increase above the cap. Many people get confused between coupon rate and yield to maturity, in reality, both are very different measures of returns.source site
As discussed, coupon rate is a fairly straightforward rate that measures the percentage of interest rate that an investor will receive periodically from the bond issuer. However, the yield to maturity is slightly complicated. To understand yield to maturity we must be familiar with some characteristics of a bond as follows:. Yield to maturity is the rate of interest that an investor gets if the bond is held till maturity. Breaking it down to little more easy language — if you buy a bond today and hold it until maturity, the return that you earn on that bond is yield to maturity.
Calculation of yield to maturity takes into account the bonds market price, its coupon payments, and its face value. As a matter of fact, the market price of a bond is determined by comparing coupon rate with the yield to maturity of that bond —.
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Investor’s Guide to Zero-Coupon Municipal Bonds | Project Invested
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