Coupon

Coupon is the annual interest paid on the face value of a bond. Coupons are generally described in terms of coupon rate which is fixed over a period of time. The coupon rate is calculated by taking the sum of all coupons paid per year and dividing it by the bond’s face value. Coupon rates depend on the probability of default of the underlying fixed income security. Securities with low credit risk have low coupon rates, while those with higher coupon rates provide higher yields to compensate for the lack of creditworthiness of the company.

Example:

Let’s assume a bond with a face value of $1000 is purchased with a coupon rate of 5%. This means that 5% of $1000, ie a $50 coupon will be paid to the bondholder annually by the issuer of the bond.