Coupon Rate Vs The Interest Rate Regarding Bonds
Bonds are issued by governments and non-governmental organizations to raise funds to fund their activities. When a person purchases a bond, the bond issuer commits to make monthly payments to the bondholder at the coupon rate specified in the issued certificate, depending on the principal amount of the bond. The issuer pays periodic interest payments until the bondholder’s initial investment — the face value (or “par value”) of the bond — is recovered (CFI Team, 2022).
Bonds also generally pay investors monthly interest payments and refund the whole principal lent when the bond expires. As a result, bond prices fluctuate inversely with interest rates, decreasing when rates rise and rising when rates fall (Parker, 2022).
Coupon Rate Vs The Interest Rate
The coupon rate is the annual interest income provided to a bondholder based on the bond’s face value (CFI Team, 2022). The coupon rate is normally fixed, which means that it does not fluctuate from the original rate established at the time the bond is issued during the life of the bond. The coupon rate is determined by dividing the total amount of coupon payments by the face value of the bond (Vaidja, 2022).
While the interest rate is the amount charged by the lender to the borrower and is computed annually based on the amount lent. The shift in the market condition has an impact on interest rates. The interest rate is determined by the issuing party and is not affected by the issue price or market value (Vaidja, 2022). Parker (2022) also stated that Bond prices will climb when interest rates fall, allowing them to be sold at a premium price.
The coupon rate of a bond, in comparison to the interest rates in the economy, decides whether it will trade at par, below par, or above par (Chen, 2022).
The Par Value
A bond’s par value is its face value. The par value of a bond or fixed-income instrument is crucial because it influences the maturity value as well as the cash amount of coupon payments. A bond’s market price may be above or below par based on factors such as interest rate levels and the bond’s credit status (Chen, 2022).
The Impacts of a Tax Shield on Fixed Income Yields
Tax shield is defined by Kagan (2020) as a reduction in taxable income achieved via the planned use of taxable expenditures to offset taxable revenue. Tax shelters are part of a company’s broader financial plan, because they raise expenditures while lowering taxable revenue. They minimize cash on hand while investing in higher-yielding assets (Kagan, 2020). According to Kagan (2020), the following formula may be used to calculate the tax shield: Tax Shield = Tax Rate x Value of Tax-Deductible Expense
References
CFI Team. (2022, October 11). Coupon rate. Corporate Finance Institute. Retrieved December 7, 2022, from https://corporatefinanceinstitute.com/resources/fixed-income/coupon-rate/
Chen, J. (2022, June 22). Par value definition. Investopedia. Retrieved December 7, 2022, from https://www.investopedia.com/terms/p/parvalue.asp
Kagan, J. (2020, May 25). What is a tax shield? Investopedia. Retrieved December 7, 2022, from https://www.investopedia.com/terms/t/taxshield.asp
Parker, T. (2022, July 31). The basics of bonds. Investopedia. Retrieved December 7, 2022, from https://www.investopedia.com/financial-edge/0312/the-basics-of-bonds.aspx
Vaidja, D. (2022, May 20). Coupon rate vs interest rate. WallStreetMojo. Retrieved December 7, 2022, from https://www.wallstreetmojo.com/coupon-rate-vs-interest-rate/
Note:
This article is written based on University of The People Financial Management (BUS 5111) written assignment by Fristy Tania in December 2022
