What Is the Meaning of a Coupon in Bonds?

Bonds represent an investment where an individual lends money to an entity, such as a government or a corporation. In return, the borrower agrees to make regular interest payments and repay the original amount, known as the principal, at a specified future date. A central aspect of this arrangement is the “coupon,” which this article clarifies.

What a Bond Coupon Is

A bond coupon refers to the fixed interest payment a bondholder receives from the bond’s issuer. Historically, bonds were physical certificates with actual coupons attached. Investors would detach, or “clip,” these coupons on specific dates and present them to receive their interest payment. While this physical practice is largely obsolete, the term “coupon” persists to describe these periodic interest payments.

Today, the coupon signifies the predetermined dollar amount of interest income an investor earns. This amount is established when the bond is initially issued and remains constant throughout the bond’s life. The coupon payment is distinct from the bond’s face value, which is the principal amount repaid at maturity.

How Coupon Payments Are Determined and Received

The dollar amount of a bond’s coupon payment is directly linked to its “coupon rate” and face value. The coupon rate is the annual interest rate applied to the bond’s face value, which is typically $1,000. To calculate the annual coupon payment, this rate is multiplied by the bond’s face value. For instance, a bond with a 5% coupon rate and a $1,000 face value will generate $50 in annual interest payments (0.05 $1,000 = $50).

Coupon payments are generally made on a regular schedule rather than as a single annual sum. The most common frequency for bond payments in the United States is semi-annually, meaning payments occur twice a year. Therefore, the $50 annual payment from the previous example would typically be received as two $25 payments, six months apart. Less common frequencies include quarterly or annually. Investors typically receive these payments as direct deposits into their brokerage or investment accounts, eliminating the need for physical coupons.

The Coupon Rate and Bond Value

While a bond’s coupon payment is a fixed dollar amount, its market price can fluctuate after issuance. These price changes are influenced by prevailing interest rates and other economic conditions. The relationship between a bond’s fixed coupon rate and its fluctuating market price determines the bond’s actual return relative to the price paid, often expressed as its “yield.”

A simple measure is the current yield, calculated by dividing the bond’s annual coupon payment by its current market price. If market interest rates rise after a bond is issued, newly issued bonds will likely offer higher coupon rates to attract investors. This makes older bonds with lower, fixed coupon rates less attractive, leading to a decrease in their market price. Conversely, when market interest rates fall, existing bonds with higher fixed coupon rates become more appealing. This increased demand drives their market price up, effectively decreasing their yield for new buyers who pay a premium. This inverse relationship between interest rates and bond prices is a fundamental aspect of bond valuation.