A coupon payment is the regular payment that the holder of a bond
gets over the life-time of the bond, until it finally matures, say in 5
years’ time. Coupon payments are typically made twice yearly by the bond
issuer to the bond holder. The ‘face value’ (called par value) of a bond
is determined when the bond is issued and is the value of the bond at
the point it matures.

Bonds can be categorised in terms of their life to maturity, with
short-term bonds maturing in less than 3 years, medium-term between 4
and 10 years, and long-term bonds greater than 10 years.

Before technological advances removed the need to physically cash-in
coupons, the issuer would sell a bond and provide the number of coupons
appropriate to the length of the bond to maturity. For example, a 5-year
bond would typically have 10 coupons attached, given that coupon
payments are commonly paid twice a year.

The coupon rate is the percentage of the value of the coupon paid in
relation to the bond’s par value. Not all bonds have a fixed coupon rate
– zero coupon bonds do not pay regular rate of interest, but pay the par
value at maturity. For these to be attractive to buyers of bonds they
are sold at a discounted price below the par value.

Floating rate coupons have a variable interest rate, which can be
changed on a periodic basis. The rate on these is usually tied (pegged)
to another security – typically Treasury Bills. As bill rates change,
bond rates are adjusted in the same direction.

For example, a fixed rate government bond issued at a par value of
£1,000 may receive two coupon payments each year of £50 each, giving an
annual return of £100. In this case the coupon rate is 100/1,000, which
is 10%. The coupon rate will stay at a fixed rate, irrespective of the
market interest rate.

Of course, the actual return to the investor (the current yield)
depends upon the actual price paid for the bond, which can rise or fall
as a result of being traded in the secondary bond market. Bond prices
can vary over the life of the bond, with bond prices depending on demand
and supply-side factors, such as the yields on alternative bond or other
investments, which can make them more or less attractive.

So, if the market price of the nominal £1,000 bond falls to £950, the
current yield would rise to 10.53% (100/950). Hence, the ** price of a
bond and its current yield vary inversely**. If an investor pays more
than the face value, par rate - i.e. pays a premium - the yield will
fall. For example, if the investor pays £1050 for the bonds, the yield
will fall to 9.52% (100/1050).

If an investor wishes to purchase an existing bond, they are likely
to want to assess the yield they will gain between the purchase date and
the maturity date* – *shortened to* ‘yield to maturity’*
(YTM). While the coupon rate is the rate which is paid out per year as a
percentage of the bond's par value, the yield to maturity is the *
total appreciation* which takes place over the life of the bond
remaining at the point of purchase, expressed as an annual % figure. The
YTM indicates how much an investor will earn if the bond is held until
it matures, including the value of the remaining coupon payments as well
as the return (the capital gain, or loss) of the principal sum upon
maturity.

This value will take into account when the bond is purchased and the
years left to maturity, and the price paid. YTM is widely used to
compare different bonds.

In our example, if an investor pays £950 for a par value bond of
£1000, with two years to maturity, as well as receiving the fixed £100
per year for two years, the investor will also benefit from the movement
in the bond price paid, from £950 back to the par value of £1000 at
maturity. When we add this £50 increase to the (remaining) coupon
payments of £100 per year, and spread this out over the two years left,
we can calculate the YTM.

UK economy contracts by 0.2% in 2nd quarter of 2019.

Read moreRead more Read more

Read more

Read more

Regulators find leading model agencies guilty of price fixing.

Read moreCosts and benefits of customs unions.

Read moreMultiple choice papers for Paper Three.

Read moreSavings ratio falls to lowest level on record.

Read more