Coupon

The coupon is a contractual cash flow, not a market variable. At issuance the indenture fixes three things: the stated rate, the par (face) amount on which that rate is applied, and the payment dates. The periodic payment equals the annual rate times par, divided by the number of payments per year. A 6% annual rate on 1,000 of par paid semiannually produces 30 every six months; paid quarterly, 15 every three months. Nothing in that arithmetic references the bond's market price.

Because the payment is contractual, missing it is an event of default rather than a business decision, which is what separates bond coupons from common dividends. This is also why the coupon anchors the bond's cash flow schedule: valuation, duration and yield calculations all take the coupon stream as given and let price or discount rate do the adjusting.

Fixed-rate coupons dominate government and investment-grade corporate issuance, but the market uses many variants. Floating-rate notes pay a reference rate plus a quoted margin, reset on a schedule, so the cash flow moves with short-term rates while the price stays comparatively stable. Step-up coupons rise on preset dates, often to discourage the issuer from leaving a callable bond outstanding. Deferred-coupon and payment-in-kind structures postpone cash interest, common in leveraged financings where the borrower needs early breathing room. Index-linked bonds tie the payment to inflation, either by indexing the coupon rate or by indexing the principal on which the coupon is computed.

Credit-sensitive features also exist: some issues carry a coupon that ratchets higher after a ratings downgrade, compensating holders for deteriorating quality without renegotiating the deal.

Coupons are paid to whoever holds the bond on the record date, so a buyer settling between payment dates owes the seller the interest earned since the last coupon. That accrued interest equals the coupon payment scaled by the fraction of the period elapsed, measured under the issue's day-count convention: actual/actual for most government bonds, 30/360 for many corporates and municipals. The quoted or clean price excludes this amount; the invoice or dirty price is the clean price plus accrued interest, and that is what actually changes hands.

This mechanic explains the sawtooth pattern in a bond's full price, which climbs as accrual builds and drops by the coupon amount on payment day, while the clean price moves only with yields. Candidates should be able to compute accrued interest from a settlement date and convert between clean and full price in either direction.

Comparing the coupon rate with the market discount rate tells you the pricing relationship immediately: when the coupon rate exceeds the required yield the bond trades above par, when it falls short it trades below par, and equality puts it at par. Current yield, the annual coupon divided by the market price, captures only this income component and ignores capital gain or loss to maturity, which is why it sits below yield to maturity for a discount bond.

Coupon size also drives risk. A low-coupon bond concentrates value in the distant principal repayment, giving it longer duration and greater price sensitivity to yield changes than a high-coupon bond of identical maturity. Conversely, high coupons return cash earlier and therefore carry more reinvestment risk. Recognising these trade-offs is the practical use of the concept in portfolio and exam settings.