- The coupon rate is the interest rate that the bondholder is entitled to receive from the bond issuer. Thus, the coupon rate determines the income that will be earned from the bond.
- The term "coupon" refers to the time when bonds literally had coupons which were detached from the bond and mailed into the issuer in order to get the interest payment. These have disappeared as bonds have become easier to track electronically.
- The coupon rate for a bond is set by the bond issuer. Theoretically, the issuer could choose any rate desired for their bond. Practically, however, a bond issue will only sell if the bond's coupon is set at a rate which coincides with the rate demanded by the marketplace. All other things being equal, a long term bond will pay a higher rate than a short term bond, and a bond issued by a higher rated (more stable) company will have a smaller coupon rate than one issued by a lower rated company. Rates will also be affected by bond repayment terms such as a Call Feature.
- The coupon rate does not necessarily determine the rate of return for a bond investment. Only bonds purchased directly from the issuer will necessarily pay the exact coupon rate. If a bond is bought in the secondary market, then the rate of return is determined by the price paid for the bond as well as the coupon rate.
- A bond whose coupon rate is higher than current interest rates will command a price above its face value, or a premium. Likewise, a bond whose coupon rate is lower than current interest rates will trade at a lower price, or a discount. An investor seeking higher current income will prefer a bond trading at a premium, while an investor preferring a gain to current income payments will prefer a discounted bond.
- Bonds, like all investments, carry a certain amount of risk to the investor. Higher coupon rates provide a higher rate of return, but also may have a higher rate of risk. It is important to evaluate all aspects of a bond before investing.
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