Key Characteristics of Bonds

Par value is the amount of money a holder will get back once a bond matures; a bond can be sold at par, at a premium, or at a discount. The coupon rate is the amount of interest that the bondholder will receive per payment, expressed as a percentage of the par value. Maturity date refers to the final payment date of a loan or other financial instrument. A callable bond allows the issuer to redeem the bond before the maturity date; this is likely to happen when interest rates go down. A sinking fund is a method by which an organization sets aside money to retire debts. Other important features of bonds include the yield, market price, and putability of a bond.

Coupon Interest Rate

The coupon rate is the amount of interest that the bondholder will receive per payment, expressed as a percentage of the par value.


LEARNING OBJECTIVE

  • Classify bonds based on coupon rate

KEY POINTS

  • Coupon interest rate is usually fixed throughout the life of the bond. It can also vary with a money market index.
  • Not all bonds have coupons. Zero-coupon bonds are those that pay no coupons and thus have a coupon rate of 0%.
  • Based on different coupon rates, there are fixed rate bonds, floating rate bonds, and inflation linked bonds.

TERM

  • time value of money

    The value of money, figuring in a given amount of interest, earned over a given amount of time.


The coupon rate is the amount of interest that the bondholder will receive expressed as a percentage of the par value. Thus, if a bond has a par value of 1,000 and a coupon rate of 10,100 a year during the time between when the bond is issued and when it matures. Usually this rate is fixed throughout the life of the bond. It can also vary with a money market index, such as LIBOR, or it can be even more exotic. The bond will also specify when the interest is to be paid, whether monthly, quarterly, semi-annually, or annually.


Mecca Temple 1922 Bond Coupons: A coupon payment on a bond is a periodic interest payment that the bond holder receives during the time between when the bond is issued and when it matures.

The name "coupon" arose because in the past, paper bond certificates were issued that had coupons attached to them, one for each interest payment. On the due dates, the bondholder would hand in the coupon to a bank in exchange for the interest payment.

Not all bonds have coupons. Zero-coupon bonds are those that pay no coupons and thus have a coupon rate of 0%. Such bonds make only one payment–the payment of the face value on the maturity date. Normally, to compensate the bondholder for the time value of money, the price of a zero-coupon bond will always be less than its face value on any date before the maturity date. The bondholder receives the full principal amount on the redemption date. An example of zero coupon bonds is Series E savings bonds issued by the U.S. government.

Based on different coupon rates, bonds are classified into many types. Fixed-rate bonds have a coupon that remains constant throughout the life of the bond. A variation are stepped-coupon bonds, with a coupon that increases during the life of the bond.

Floating rate notes (FRNs, floaters) have a variable coupon that is linked to a reference rate of interest, such as LIBOR or Euribor. For example, the coupon may be defined as three month USD LIBOR + 0.20%. The coupon rate is recalculated periodically, typically every one or three months.

Inflation linked bonds (linkers), in which the principal amount and the interest payments are indexed to inflation. The interest rate is normally lower than for fixed rate bonds with a comparable maturity. However, as the principal amount grows, the payments increase with inflation. The United Kingdom was the first sovereign issuer to issue inflation linked Gilts in the 1980s. Treasury Inflation-Protected Securities (TIPS) and I-bonds are examples of inflation linked bonds issued by the U.S. government.