The price of a coupon bond can best be described as

Definition of 'Coupon Rate'

More advanced finance courses will introduce students to advanced bond concepts including duration, managing bond portfolios, understanding and interpreting term structures, etc. A bond is a debt instrument that provides a periodic stream of interest payments to investors while repaying the principal sum on a specified maturity date. The face value also known as the par value of a bond is the price at which the bond is sold to investors when first issued; it is also the price at which the bond is redeemed at maturity. In the U.

Occasionally a bond is issued with a much longer maturity; for example, the Walt Disney Company issued a year bond in There have also been a few instances of bonds with an infinite maturity; these bonds are known as consols. With a consol, interest is paid forever, but the principal is never repaid.

Many bonds contain a provision that enables the issuer to buy the bond back from the bondholder at a pre-specified price prior to maturity.

Much more than documents.

This price is known as the call price. A bond containing a call provision is said to be callable.

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This provision enables issuers to reduce their interest costs if rates fall after a bond is issued, since existing bonds can then be replaced with lower yielding bonds. Since a call provision is disadvantageous to the bond holder, the bond will offer a higher yield than an otherwise identical bond with no call provision. Some bonds contain a provision that enables the buyer to sell the bond back to the issuer at a pre-specified price prior to maturity.

This price is known as the put price.

Bond Investment Strategies

A bond containing such a provision is said to be putable. This provision enables bond holders to benefit from rising interest rates since the bond can be sold and the proceeds reinvested at a higher yield than the original bond. Since a put provision is advantageous to the bond holder, the bond will offer a lower yield than an otherwise identical bond with no put provision. Some bonds are issued with a provision that requires the issuer to repurchase a fixed percentage of the outstanding bonds each year, regardless of the level of interest rates. A sinking fund reduces the possibility of default ; default occurs when a bond issuer is unable to make promised payments in a timely manner.

Cash Value Whole Life Beats Zero-Coupon Bonds

Since a sinking fund reduces credit risk to bond holders, these bonds can be offered with a lower yield than an otherwise identical bond with no sinking fund. Bonds are issued by borrowers to raise funds for long-term investments; the main issuers of bonds in the U. Treasury securities are issued by the U. These are free of default risk , which is the risk that the investor will not receive all promised payments.

3.4 - The Prices and Yields of Coupon Bonds

They are not taxed by state and local governments, but are taxed at the federal level. Another key difference between these securities is that Treasury bills are sold at a discount from their face value and redeemed at face value; Treasury notes and bonds are sold and redeemed at face value and pay semi-annual coupons to investors. Corporations can raise funds by issuing debt in the form of corporate bonds.

Bond Stated Interest Rate Vs. Market Rate

These bonds offer a higher promised coupon rate than Treasuries, but expose investors to default risk. The riskiest corporations offer the highest coupon rates to investors as compensation for default risk. A municipal bond is issued by a state or local government; as a result, they carry little or no default risk. Interest rates can change, but that will affect the yield, not the coupon rate. If interest rates rise, then the price the bond can be sold at will decrease, raising the underlying yield to maturity to match the increasing interest rate.

Though this may seem basic and simple as I explain it, believe me, it has proven to be a major source of confusion. If the ask price matches the face value, then the yield would be the same as the coupon. If the ask price is higher, then the yield will be less than the coupon, and if the ask price is lower, then the yield will be higher than the coupon. This gets back to the point I was stressing before about how the coupon rate never changes. The bond provides a promise for a fixed set of payments.

It pays all of the fixed coupon amounts and repays the face value at the maturity date. These payments do not change. But bonds can be sold and resold on secondary markets prior to the maturity date. Lower ask prices imply higher yields, and vice versa.

What is Bond Pricing Formula?

Share to facebook Share to twitter Share to linkedin As a bond provides a contractual right to a series of future payments received at specified points of time, the price for a bond is simply the present discounted value of the future cash flows. Typically, private companies will hire an investment bank to underwrite the bond issue. The investment bank, or syndicate of multiple investment banks, will purchase the entire bond issue and resell the bonds to large-scale and institutional investors on the open market. Many governmental entities, such as the United States Treasury, will sell bonds directly to large-scale investors through auctions rather than using an underwriter as a middleman.

The amount paid by investors for a bond, whether purchased through a direct auction, an underwriter or from another investor is the bond's market price. When the market price is less than face value, then the market rate, or yield, of that bond will be greater than the coupon rate.

When the market price is greater than face value, then the market yield of that bond will be less than the coupon rate. Therefore, the relationship of the coupon rate and the market yield depends upon the market price of the bond. Ryan Cockerham is a nationally recognized author specializing in all things innovation, business and creativity.