Coupon Rate

The coupon rate is the annual interest that a bond issuer promises to pay, expressed as a percentage of the bond's face value (also called par or principal). A bond with a face value of 1,000 and a coupon rate of 8% pays 80 a year, usually split into two or four payments, until it reaches maturity and the face value is repaid. The rate is fixed in the bond's terms when it is issued.

The coupon rate is a contractual figure, not a market one. It tells you how much cash the bond pays, but not what return an investor actually earns, which depends on the price paid. That return is measured by yield. The coupon applies to most bonds, including Treasury Bonds (TBs), corporate bonds and Pakistan Investment Bonds (PIBs), but not to discount instruments such as Treasury Bills (TBs).

Think of lending a friend money and agreeing a fixed "thank you" payment every year until they pay you back. The coupon rate is that agreed thank-you, written as a share of the amount lent. It does not change if your friend later gets a pay rise, or if other people start lending at higher or lower rates.

The word comes from old paper bonds, which had small tear-off coupons printed along the edge. Each one was dated, and the holder cut it off and presented it to a bank to collect that period's interest. Bonds are now held electronically, but the name stuck.

The coupon rate is calculated as:

• $C$ is the total coupon paid in a year.
• $F$ is the face value of the bond.

Each instalment is the annual coupon divided by the number of payments a year:

• $c$ is the coupon rate as a decimal.
• $n$ is the number of payments per year (2 for semi-annual, 4 for quarterly).

Example: a five-year government bond has a face value of Rs 100,000 and a 12% coupon paid semi-annually. The annual coupon is $0.12 \times 100{,}000 = 12{,}000$, paid as two instalments of Rs 6,000. Over five years the holder receives ten payments totalling Rs 60,000, plus the Rs 100,000 face value at the end.

Once a bond is issued, its price moves with market interest rates, but its coupon stays the same. This creates the difference between coupon and yield:

• Bond at par. If the price equals face value, the current yield equals the coupon rate.
• Bond at a discount. If market rates rise above the coupon, the price falls below par, and the yield is higher than the coupon.
• Bond at a premium. If market rates fall below the coupon, the price rises above par, and the yield is lower than the coupon.

The simplest measure is current yield: annual coupon divided by price. If the Rs 100,000 bond above trades at Rs 96,000, its current yield is $12{,}000 \div 96{,}000 = 12.5\%$. A fuller measure, yield to maturity, also counts the gain from buying below par and uses a discount rate to value every future payment. When governments auction new bonds, they usually set the coupon close to the yield the market demands, so that the bond sells near par.

• Fixed coupon. The rate is set for the whole life of the bond. Most government and corporate bonds work this way.
• Floating coupon. The rate resets at intervals to a benchmark plus a margin. Benchmarks include SOFR in the US, formerly LIBOR, and in Pakistan the 6-month Market Treasury Bill yield or KIBOR.
• Zero coupon. No periodic interest is paid; the bond is sold below face value and the return is the gap between price and par.
• Step-up and inflation-linked coupons. Some bonds raise the coupon on set dates, while inflation-linked bonds adjust the principal or coupon in line with a price index such as the Consumer Price Index (CPI).

Islamic bonds, or sukuk, pay periodic "rental" or profit distributions instead of interest, which is prohibited as riba, but these payments are often quoted in a similar way.

An issuer's coupon reflects the general level of rates when it borrows, the bond's term (longer bonds usually pay more, as shown by the yield curve) and its credit risk. A lower-rated company must offer a wider credit spread over government bonds. Features also matter: a convertible bond pays a lower coupon because investors gain the option to switch into shares.

• Investor.gov (US SEC): Coupon rate
• TreasuryDirect: Treasury Bonds