What is a Coupon?

//What is a Coupon?
What is a Coupon? 2017-10-02T07:45:18+00:00

Definition: A coupon, in relation to bond instruments, is an interest payment made to the bondholder during the term of the bond. It is used to compensate the holder for lending their money.

What Does Coupon Mean?

What is the definition of coupon? The term coupon refers back to when bonds were printed on paper. The bond holder would receive a certificate representing the bond. On the side there would be detachable pieces of paper, also known as coupons, that the holder could tear off and present to the entity that issued the bond in order to receive the coupon payment.

Coupon rates are set by the companies or governments that issue the bonds and can vary immensely depending on the duration of the term of the bond and/or the stability of the issuing entity. For example, a bond that has a 30-year term may have a higher rate than a 1-year note, in order to compensate the holder for having to wait longer for the final payment.

Similarly, if the entity that issues the bond is considered less stable, they may have to offer higher payments in order to compensate the holder for the risk they face by lending to that company. For example, US Treasury bonds are considered very secure and historically have very low interest rates while younger companies often provide higher coupon rates to entice investors.

Some bonds do not offer these payments. Instead, they are sold at a discount. For example, the buyer purchases the bond for $900 and receives $1,000 when the bond matures.

Similar terms are coupon rate and nominal yield.

Example

Coupon payments are often discussed in annual percentages. For instance, if a bond has a face value of $1,000 and pays $30 per year, the bond would be said to have a 3% coupon. The actual payment could be made as one annual payment of $30, 2 semi-annual payments of $15 each or monthly payments of $2.50 depending on the terms of the bond.

Summary Definition

Define Coupons: Bond coupon means a document turned in for receipt of bond payments.