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Difference Between Coupon Rate vs Interest Rate
In this article, we look at the differences between Coupon Rate vs Interest Rate?
What is Coupon Rate?
The coupon rate is the rate of interest being paid off for the fixed income security such as bonds. This interest is paid by the bond issuers where it is being calculated annually on the bonds face value, and it is being paid to the purchasers. Usually, the coupon rate is calculated by dividing the sum of coupon payments by the face value of a bond. Bonds are issued by government and companies in order to raise capital to finance their operations. So, coupon rate is the amount of yield paid by the issuer to their purchasers, but it is a certain percentage amount calculated on the face value.
What is Interest Rate?
The interest rate is the amount charged by the lender from the borrower, which is calculated annually on the amount that has been lent. The interest rates are being affected with change in the market scenario. The interest rate does not depend on the issue price or market value; it is already being decided by the issuing party. The market interest rates have effects on the bond prices and yield, wherein the increase in the market interest rates will reduce the fixed-rates of the bond.
Coupon Rate vs Interest Rate Infographics
Here we provide you with the top 8 difference between Coupon Rate vs Interest Rate
Coupon Rate vs Interest Rate – Key Differences
The key differences between Coupon Rate vs Interest Rate are as follows –
- The coupon rate is calculated on the face value of the bond which is being invested. The interest rate is calculated considering on the basis of the riskiness of lending the amount to the borrower.
- The coupon rate is decided by the issuer of the bonds to the purchaser. The interest rate is decided by the lender.
- Coupon rates are largely affected by the interest rates decided by the government. If the interest rates are set to 6% then no investor will accept the bonds offering coupon rate lower than this. Interest rates are decided and controlled by the government and are dependent on the market conditions
- Consider two bonds with all characteristics similar apart from the coupon rates. The bond with lower coupon rates will have a greater decrease in value when the interest rate rises. Bonds with low coupon rates will have higher interest rate risk than bonds that have higher coupon rates
- For example, consider a bond with a coupon rate of 2% and another bond with a coupon rate of 4%. Keeping all the features same, bond with a 2% coupon rate will fall more than the bond with a 4% coupon rate
- Maturity affects interest rate risk. The longer the bank’s maturity the higher the chances of it to be affected by the changes interest rate prior to maturity. This may have a negative effect on the price of the bond. Longer maturity will have a higher interest rate risk while shorter maturity will have a lower interest rate risk
- To compensate for this high-interest rate risk, bonds generally offer a high coupon rate for high-interest rate and longer maturity bonds. Similarly, shorter maturity bonds will have a lower interest rate risk and lower coupon rate
- If the investor purchases a bond of 10 years, of a face value of $1,000 and a coupon rate of 10 percent then the bond purchaser gets $100 every year as coupon payments on the bond. If a bank has lent $ 1000 to a customer and the interest rate is 12 percent then the borrower will have to pay charges $120 per year.
Coupon Rate vs Interest Rate Head to Head Difference
Let’s now look at the head to head difference between Coupon Rate vs Interest Rate
|Particulars – Coupon Rate vs Interest Rate||Coupon Rate||Interest Rate|
|Meaning||Coupon rate can be considered as the yield on a fixed income security||The interest rate is the rate charged by the lender to the borrower for the borrowed amount|
|Calculation||The coupon rate is calculated on the face value of the bond which is being invested.||The interest rate is calculated considering on the basis of the riskiness of lending the amount to the borrower.|
|Decision||The coupon rate is decided by the issuer of the bonds to the purchaser.||The interest rate is decided by the lender.|
|Effect of interest rates on the coupon||Coupon rates are largely affected by the interest rates decided by the government. If the interest rates are set to 6% then no investor will accept the bonds offering coupon rate lower than this||Interest rates are decided and controlled by the government and are dependent on the market conditions|
|Relationship||Bonds with lower fixed rate coupon will have a higher interest rate risk and higher fixed rate coupon bonds will have lower interest rate risk||Interest rates are not affected by individual coupon rates of the bonds|
|Example||If the investor purchases a bond of 10 years, of a face value of $1,000 and a coupon rate of 10 percent then the bond purchaser gets $100 every year as coupon payments on the bond.||If a bank has lent $ 1000 to a customer and the interest rate is 12 percent then the borrower will have to pay charges $120 per year.|
|Maturity duration||1. With longer maturity of the bond, the coupon rate is higher.
2. Shorter maturity of the bond reduces the coupon rate.
|1. Longer maturity duration increases the interest rates which affects the interest amount.
2. Shorter maturity duration reduces the risk of interest rates.
|Types||Coupon can be of two types Fixed rate and Variable rate. Fixed rate does not change and fixed till maturity while the variable rate changes every period.||Interest rate does not have any types and is fixed until the regulatory body decides to change it.|
If the investor intends to hold the bond to maturity, the day to day fluctuations in the bonds price may not be that important. The bonds price will change but the stated interest rate will be received. On the other hand, instead of holding the bonds until maturity the investor can sell the bond and reinvest the money or the proceeds into another bond that pays a higher coupon rate.
This has been a guide to the Coupon Rate vs Interest Rate. Here we discuss the top differences between Coupon Rate vs Interest Rate along with infographics and comparison table. You may also have a look at the following articles –