Coupon Rate

The coupon rate is fixed when a bond is issued and determines the size of each interest payment. A bond with a face value of 1,000 and a coupon rate of 5% pays 50 of interest a year.

The coupon rate is set based on market interest rates and the issuer's creditworthiness at the time of issue. A government with excellent credit may pay a low coupon rate, while a company with weaker finances must offer a higher rate to attract investors.

Once issued, the coupon rate usually does not change, but the bond's market price does. This creates a difference between the coupon rate and the bond's yield. If a 5% bond's price falls to 950, investors buying it receive the same 50 a year, but because they paid less, their effective yield is higher.

So the coupon rate tells you how much cash a bond pays, while the yield tells you the return an investor actually earns at the current price. When market rates are above a bond's coupon rate, the bond typically trades below its face value, and when market rates are below the coupon rate, it trades above face value.