In other words, it is the stated rate of interest paid on fixed income securities, primarily applicable to bonds.
The formula for coupon rate is computed by dividing the sum of the coupon payments paid annually by the par value of the bond and then expressed in terms of percentage. Conversely, the equation of the coupon rate of a bond can be seen as the percentage of the face value or par value of the bond paid every year.
Coupon Rate
Step 1: Firstly, figure out the face value or par value of the issued bond. It will be easily available in the funding proposal or the accounts department of the company. Step 2: Next, determine the no. Then all the periodic payments are added up to calculate the total coupon payment during the year. In case of equal periodic payments, the total annual coupon payment can be computed by multiplying the periodic payments and the no. Let us take an example of bond security with half-yearly coupon payments. Do the Calculation of the coupon rate of the bond. Let us take another example of bond security with unequal periodic coupon payments.
It returns a clean price and a dirty price market price and calculates how much of the dirty price is accumulated interest. Accumulated interest on a bond is easy to calculate. As in our yield to maturity calculator, this is a hard problem to do by hand.
Time to maturity and bond price
The trading price of a bond should reflect the summation of future cash flows. Let us first show how this is done in a spreadsheet program. You will want to start by creating a spreadsheet such as the above.
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The price that a bond sells for in the market today is the sum of all future cash flows, discounted in value because they are not available today. A dollar tomorrow is worth less to you than a dollar today.
The discount rate used is the rate of interest prevailing in the market for bonds of the same risk and maturity. When that interest rate changes, it affects the price of all bonds, but to varying degrees. The reason is that the maturity value of the long-term bond, as well as many of the interest payments that are being paid, are future cash flows that are very distant points in the future. If interest rates rise, those very distant cash flows of the long-term bond are discounted in value significantly, and the price of the long-term bond falls in the market abruptly.
Coupon rates—the periodic interest payment that is paid by the issuer of the bond—also affect bond price volatility. A higher coupon means that more cash in the form of interest payments flows to the investor before maturity than is the case with a lower coupon bond. What this means is that when interest rates rise and future cash flows are discounted at a higher rate, the lower coupon bond has relatively more cash flow in the distant future, the maturity value of the bond represents a greater portion of the total cash flow, and the bond's value today will fall relatively more.
Combining these characteristics produces the riskiest bonds in terms of price volatility: The most price volatile bonds are those with longer maturities and lower coupons. A long-term zero-coupon bond defines the outer boundary for riskiness. Investors who are risk averse should look for bonds and bond mutual funds that have shorter average maturities—less than five years—and should avoid zero-coupon bonds, particularly long-term zero-coupon bonds.
Table 1 indicates just how much bond prices can change when interest rates change.
How it works/Example:
The table shows the percentage change in bond price for a given interest rate change for bonds of different maturities and two different coupon rates. The table is based on the assumption of semiannual interest payments and bonds selling at their maturity face value.
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.
Real Financial Planning
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. 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.