Fixed-income securities like bonds are essentially IOUs (I Owe You) issued by governments and companies. You, the investor, loan them money, and in return, they promise to pay you back the principal amount (the amount you loaned) along with interest at specified intervals. This interest payment is called the coupon.
The coupon rate is that interest rate expressed as a percentage of the bond’s face value, also known as its par value. It represents the annual fixed interest you’ll receive if you hold the bond until its maturity date.
Here’s how coupon rates work:
- Example: Let’s say you invest in a bond with a face value of ₹1,000 and a coupon rate of 8%. This means you’ll receive an annual interest payment of ₹80 (8% of ₹1,000).
Key points to remember about coupon rates:
- Fixed vs. Yield: The coupon rate is fixed at the time the bond is issued, whereas the yield can fluctuate depending on the market price of the bond.
- Higher Coupon Rate, Higher Interest: Generally, bonds with higher coupon rates offer a higher annual interest income.
- Not the Whole Picture: While coupon rates are important, they aren’t the only factor to consider when choosing fixed-income investments. You’ll also want to look at the bond’s creditworthiness, maturity date, and potential for early redemption.
