Legal Definitions - coupon rate

The coupon rate refers to the annual interest rate that a bond issuer promises to pay to the bondholder, expressed as a percentage of the bond's face value (also known as par value). This rate is fixed at the time the bond is issued and determines the amount of the periodic interest payments (often semi-annual or annual) the bondholder will receive throughout the bond's life.

Historically, bonds came with physical coupons that investors would clip and redeem for their interest payments, hence the term "coupon rate." Today, these payments are typically made electronically, but the terminology persists.

• Example 1: Government Treasury Bond

  Imagine the U.S. Treasury issues a new bond with a face value of $1,000 and a 3% coupon rate. An investor purchases this bond. Every year, the U.S. Treasury will pay the bondholder $30 (3% of $1,000) in interest, typically in two semi-annual payments of $15 each, until the bond matures.

  This example illustrates the coupon rate as the fixed percentage (3%) applied to the bond's face value ($1,000) to determine the consistent annual interest payment ($30) the investor receives.

• Example 2: Corporate Infrastructure Bond

  A large construction company issues bonds to finance a new bridge project. Each bond has a face value of $5,000 and carries a 4.2% coupon rate. An institutional investor buys several of these bonds. For each bond held, the company commits to paying the investor $210 annually (4.2% of $5,000) until the bond's maturity date.

  Here, the 4.2% coupon rate dictates the fixed annual income ($210 per bond) that the corporate bondholder will earn from their investment, regardless of how the bond's market price might fluctuate.

• Example 3: Municipal Water Project Bond

  A local city government issues municipal bonds to fund improvements to its water treatment facilities. These bonds have a face value of $10,000 and a 2.5% coupon rate. A retired couple invests in one of these bonds for a steady income stream. The city will pay them $250 per year (2.5% of $10,000) in interest until the bond reaches its maturity.

  This scenario demonstrates how the 2.5% coupon rate establishes the predictable annual interest payment ($250) that the city, as the issuer, is obligated to pay to the bondholder for the duration of the bond.