Coupon Rate

The coupon rate is the interest rate printed on a bond. A bond with a face value of 1,000 and a 5% coupon pays 50 a year. It is fixed at issue and does not change until maturity.

What confuses people is that the coupon rate and the actual return differ. Buy the bond below face value and your real return exceeds the coupon; buy above it and the return falls short.

Pay 900 for a bond with a face value of 1,000, for instance, and you still collect the 50 in interest while receiving 1,000 at maturity. The effective return is well above 5%.

When market rates rise, existing bonds with lower coupons look less attractive and their prices fall. When rates drop, the fixed interest on older bonds looks comparatively good and prices rise.

So never read the coupon rate alone — check what the bond costs today as well. The actual return if held to maturity is called the yield to maturity.