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What Is Coupon Rate and How Do You Calculate It?
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- Difference Between Coupon Rate vs Interest Rate;
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Particulars — Coupon Rate vs Interest Rate. 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.
Because of the mathematics of the relative change, the gains are always larger than the losses for the same interest rate change. Both of these interest rate changes are a bit on the high side but not impossible, and the gains and losses are large because the bond maturity is so long. You can see from the table that the lower-coupon bond at the same maturity has greater price volatility.
A higher coupon rate for the same maturity would result in smaller but still very significant price changes. If you are concerned about the price volatility of a portfolio of bonds, such as a bond mutual fund, you can use the portfolio's average maturity and the average coupon rate for a rough idea of the price volatility of the overall portfolio.
What is a Coupon Rate?
For mutual funds, this information can be found using simple arithmetic and the information on the fund's portfolio composition contained in the fund's annual, semiannual and quarterly reports. The volatility indicated will be only a rough idea of what to expect, because the mutual fund portfolio manager may lengthen or shorten the average maturities over time in anticipation of interest rate changes.
However, the mutual fund's investment objective statement found in the prospectus generally restricts major changes in maturity. There are also some important qualitative factors that affect bond price changes. The table details price changes for bonds generically. The realities of the marketplace are that when interest rates rise, lower-rated bonds—those with higher default risks—tend to fall faster in price.
This distinction holds for corporate and municipal bonds alike, but is obviously not relevant for U. A rise in interest rates in a deteriorating economic environment would drop the price of a low-rated bond—a high-yield junk bond—much faster than the price of a triple-A-rated corporate bond of the same maturity.
The table should give you a feel for bond price volatility without going through the actual math of calculating bond price changes. Even though a bond you hold may not have the exact coupon or maturity combination found in the table, you can "eyeball" the table for a useful estimate of bond price change in the event of interest rate changes. A look at the table should leave you with the notion that, if you want to be conservative and risk-averse, you should stick with short-term bonds and bond funds. If you feel that you can forecast the direction of interest rates—and, keep in mind, even Alan Greenspan's record was spotty—then an expectation of interest rate declines should trigger a move into longer-term, lower-coupon investments and an expectation of rising rates should trigger a move into shorter-term higher-coupon issues.
And remember, transaction costs and tax considerations alone make bond interest rate anticipation switches costly. Jim, most bonds pay a fixed amount of interest, so the interest payments you receive aren't affected by the bond price.
What a Bond Coupon Is and Why It Is Called That
Yield, which calculates the interest payment in relation to the bond's price, does change, but not the actual interest payment made. Hey Edward or others, My experience with GNMA funds is that they are coupon clippers and don't move much with interest rate changes.
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A bond is a long-term investment. Bond purchases should be made in line with your financial goals and planning. If you sell a bond before it matures or buy a bond in the secondary market, you most likely will catch the bond between coupon payment dates. The buyer compensates you for this portion of the coupon interest, which generally is handled by adding the amount to the contract price of the bond.
As the name suggests, these are bonds that pay no coupon or interest. Instead of getting an interest payment, you buy the bond at a discount from the face value of the bond, and you are paid the face amount when the bond matures.
Zero Coupon Bond Calculator
A bond rating agency assesses the financial strength of a company or government agency and its ability to meet debt payment obligations, then assigns it a grade that reflects the level of confidence an investor should have in that company or government agency. Bonds receive a graded rating that reflects the risk associated with investing in a bond. The A and BBB rated bonds are considered medium credit quality and anything below that is considered low quality or, what some investors refer to as junk bonds.
Morningstar has grown in status recently and could be considered the fourth primary rating agency. If the corporation or government agency that issued the bond goes bankrupt, it sells all its assets and pays back investors in a pre-determined order known as liquidation preference. The typical order is to start with senior debtors, which usually are bondholders and banks.
When senior debtors are paid, if there is money left over, it goes to the next category of investors, know as junior or subordinated debtors. These generally are large corporations or business entities. A bond unit investment trust is a fixed portfolio of bond investments that are not traded, but rather held to maturity for a specified amount of time. The length of time to maturity is set when the trust is formed and at the end of that, the investor receives his principal back, just as he would if investing in a single bond.
Along the way, investors receive interest payments, typically on a monthly basis. This is considered a low-risk investment, though the fees associated with it can eat into the profits. The bond unit investment trusts operate much like a mutual fund in the sense that you are investing in a large group of bonds and not just one.