Bond coupon

What it means

A bond coupon is the regular interest an issuer pays to the holder of a bond. It is expressed as a percentage of nominal value: 5% a year on a bond with a nominal value of 1,000 euros means 50 euros a year, paid in one sum or in half-yearly or quarterly instalments.

A coupon can be fixed, with the rate known for the whole term, or floating, linked to a reference rate such as EURIBOR plus a margin. A fixed coupon gives certainty of income, while a floating one protects the investor when interest rates rise.

There are also zero-coupon bonds that pay no interest. They are bought at a discount to nominal value, and the full nominal value is paid at maturity. The return is the difference between purchase price and nominal value, which the yield to maturity also captures.

How it works in practice

The coupon rate is not the same as the investor's return. If a bond is bought below nominal value, the actual return is higher than the coupon; if bought above, it is lower. To compare bonds with different prices and maturities, the yield to maturity is used rather than the coupon alone.

When a bond is bought between two coupon dates, the buyer pays the seller accrued interest, the interest built up since the last payment. At the next payment date the buyer receives the full coupon, so in effect they earn interest only for the time they held the bond.

For individuals, the coupon is capital income. On bonds from Slovak issuers, tax is usually collected as withholding tax at payment, while for foreign bonds the income may need to be reported in the tax return. Companies include coupons in their ordinary income.

What to watch out for

A high coupon often signals a riskier issuer. Companies and projects that cannot borrow cheaply from a bank offer investors attractive rates, but if they run into trouble they may pay neither coupon nor principal. Before buying corporate bonds, check the issuer's financial position and any security.

The market price of a fixed-coupon bond falls when interest rates rise, which is interest rate risk. If the investor has to sell before maturity, they may make a loss even though the issuer pays everything on time. When the bond is held to maturity, this effect does not show.