Coupon Rate: Definition, Formula & Calculation

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  • 0:00 Defining Coupon Rate
  • 1:35 Coupon Rate Formula
  • 1:45 Coupon Rate…
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Lesson Transcript
Instructor: Michael Cozad

Michael is a financial planner and has a master's degree in financial services.

This lesson will define coupon rate, a term used in fixed-income investing. The formula for coupon rate will be given, along with a calculation using the coupon rate.

Defining Coupon Rate

Have you ever loaned a friend money? Certainly you expected to be paid back and possibly with interest. If your friend borrowed $1,000 from you and you requested a ten percent annual interest rate, each year the loan was outstanding, your friend paid you $100 in interest. Upon maturity (the point of which the loan was due), your friend paid you back the $1,000. If the maturity date was one year from when you loaned your friend the money, then you would receive $1,100 at maturity.

The $100 is the annual interest. If you divide the annual interest by $1,000, which was the initial loan amount, your annual yield is ten percent. This is the same as the interest rate you requested. The coupon rate of ten percent is fixed because it is based on the par value, or face value, of the bond. However, it is important to note that if the price of bond changes, the yield will change. A bond price may change because interest rates vary over time. If the price of a bond declines because of a change in interest rates, or because lenders no longer deem the company as credit-worthy, the yield will increase.

The coupon rate is the annualized interest also referred to as the coupon, divided by the initial loan amount. The initial loan amount is the par value. In the example given, the coupon rate is the interest rate you requested, 10%. Coupon rates are used in the realm of fixed-income investing, mainly when dealing with bonds.

Coupon Rate Formula

The formula for coupon rate is as follows:

C = i / p

where:

  • C = coupon rate
  • i = annualized interest (or coupon)
  • p = par value of bond

Coupon Rate Calculation Example

Let's look at an example. XYZ Company, the fictitious maker of widgets, is looking to expand its brick-and-mortar stores. To do so, it needs an infusion of cash, since it has little money in the corporate checking account. The company desires to open two new stores, each costing one million dollars. In total, XYZ Company needs two million dollars. The company files the necessary paperwork and holds a bond offering.

XYZ Company is offering 2,000 bonds, each with a par value of $1,000. If you multiply the number of bonds by the par value, you will see the result is the amount needed to open the two new stores. The bonds will mature in five years, and potential lenders may compare the coupon offered by the XYZ Company bonds with similar offerings to see if it would be a wise decision.

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