Definition: The contract rate; also called the coupon rate, stated rate, or nominal rate; is the interest percentage listed on the face of a note or bond. In other words, this is the interest rate that will be paid on the principle balance for the life of the note or bond. You can think of it as the fee for borrowing the principle amount of money.
What Does Contract Rate Mean?
Every note and bond has payment terms that determine the total amount borrowed, interest rate, number of payments, and payment schedule. These terms are usually stated on the face of the bond or note. The contract rate is usually listed as an annual interest rate even if the payments are monthly, quarterly, or semi-annually.
For example, a 10 percent $1,000 par value bond would pay $100 of interest per year. The interest total is then split into payments. A quarterly bond would make four $25 interest payments each year. Occasionally bonds and notes list interest rate in other terms like semi-annual interest rates, but these exceptions are typically explicitly stated. If a bond simply lists a 10 percent rate, it is safe to assume that this refers to a 10 percent annual rate.
Remember, the contact rate is the amount of interest paid or received in cash for a bond or note. This is not the necessarily the interest expense recorded on the books. Interest expense is calculated based on the market rate of interest. Bonds issued at a premium have a higher stated rate than the market rate. Conversely, Bonds issued at a discount have a lower stated rate than the market rate. These differences in the two interest rates affects the amount the bond issuer will record for interest expense.
Only when the contract rate and the market rate are equal will the issuer interest expense equal the stated rate.