Coupon Rate Formula

Formula to Calculate Coupon Rate

Coupon Rate Formula is used for the purpose of calculating the coupon rate of the bond and according to the formula coupon rate of the bond will be calculated by dividing the total amount of annual coupon payments with the par value of the bonds and multiplying the resultant with the 100.

The term “coupon rateCoupon RateThe coupon rate is the ROI (rate of interest) paid on the bond's face value by the bond's issuers. It determines the repayment amount made by GIS (guaranteed income security). Coupon Rate = Annualized Interest Payment / Par Value of Bond * 100%read more” refers to the rate of interest paid to the bondholders by the bond issuersThe Bond IssuersBond Issuers are the entities that raise and borrow money from the people who purchase bonds (Bondholders), with the promise of paying periodic interest and repaying the principal amount when the bond matures.read more. In other words, it is the stated rate of interest paid on fixed income securities, primarily applicable to bonds. The formula for coupon rate is computed by dividing the sum of the coupon payments paid annually by the par value of the bond and then expressed in terms of percentage.

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For eg:
Source: Coupon Rate Formula (wallstreetmojo.com)

Conversely, the equation of the coupon rate of a bond can be seen as the percentage of the face value or par value of the bond paid every year.

Coupon Rate Calculation (Step by Step)

The coupon rate can be calculated by using the following steps:

Examples 

Example #1

Let us take an example of bond security with half-yearly coupon payments. Let us assume a company PQR Ltd has issued a bond having the face value of $1,000 and quarterly interest payments of $25. Do the Calculation of the coupon rate of the bond.

Annual Coupon Payment

• Annual coupon payment = 2 * Half-yearly coupon payment
• = 2 * $25
• = $50

Therefore, the calculation of the coupon rate of the bond is as follows –

Coupon Rate of the Bond will be –

Example #2

Let us take another example of bond security with unequal periodic coupon payments. Let us assume a company XYZ Ltd has paid periodic payments of $25 at the end of 4 months, $15 at the end of 9 months, and another $15 at the end of the year. Do the Calculation of the coupon rate of the bond if the par value is $1,000.

Therefore, the calculation of the coupon rate of the bond is as follows,

Coupon Rate of the Bond will be –

Example #3

Dave and Harry are two bondholders of ABC Ltd. The company has made equal quarterly payments of $25. The par value of the bond is $1,000, and it is trading $950 in the market. Determine which statement is correct:

1. Dave said that the coupon rate is 10.00%
2. Harry said that the coupon rate is 10.53%

Annual Coupon Payment

• Annual coupon payment = 4 * Quarterly coupon payment
• = 4 * $25
• = $100

Therefore, the coupon rate of the bond can be calculated using the above formula as,

Coupon Rate of the Bond will be –

Therefore, Dave is correct. [Harry has mistakenly used the market price of $950 in the place of par value for the calculation of coupon rate, i.e., $100 / $950 * 100% = 10.53%]

Relevance and Uses

It is important to understand the concept of coupon rate because almost all types of bonds pay annual payment to the bondholder, which is known as coupon payment. Unlike other financial metrics, the coupon payment in terms of the dollar is fixed over the life of the bond. For example, if a bond with a face value of $1,000 offers a coupon rate of 5%, then the bond will pay $50 to the bondholder until its maturity. The annual interest payment will continue to remain $50 for the entire life of the bond until its maturity date irrespective of the rise or fall in the market value of the bond.

Based on the coupon rate and the prevailing market rate of interest, it can be determined whether a bond will trade at a premium, par, or discount.

• A bond trades at a premiumBond Trades At A PremiumA premium bond refers to a financial instrument that trades in the secondary market at a price exceeding its face value. This occurs when a bond’s coupon rate surpasses its prevailing market rate of interest. For instance, a bond with a face value (par value) of $750, trading at $780, will reflect that the bond is trading at a premium of $30 ($780-750). read more when the coupon rate is higher than the market interest rate, which means that the price of the bond will fall because an investor will be reluctant to purchase the bond at that value.
• Again the bond will trade at a discount when the coupon rate is lower than the market interest rate, which means the price of the bondPrice Of The BondThe bond pricing formula calculates the present value of the probable future cash flows, which include coupon payments and the par value, which is the redemption amount at maturity. The yield to maturity (YTM) refers to the rate of interest used to discount future cash flows.read more will increase because an investor will be willing to purchase the bond at a higher value.
• A bond trades at par when the coupon rate is equal to the market interest rate.

Recommended Articles

This has been a guide to what is Coupon Rate Formula. Here we learn how to calculate the Coupon Rate of the Bond using practical examples and a downloadable excel template. You can learn more about Accounting from the following articles –

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