What Are Coupon Bonds?
A coupon bond is an investment that pays a regular interest payment to the holder of the security.
The issuer guarantees that it will pay this amount as long as they hold on to the coupon bond. The issuer is also obligated to repay the whole of the bond’s face value on its maturity date.
Coupon bonds are typically paid twice per year by sending out coupons or certificates that can be redeemed for cash.
Coupon bonds are issued by corporations and governments alike, but they differ in how they work and their risk level.
How Do Coupon Bonds Work?
Bonds are usually issued with a face value or principal amount that is repaid when the bond matures.
The issuer keeps up its end of the bargain by making sure to pay back this money at some point, typically after several years.
Coupon bonds work differently in that they do not have to be paid upon maturity; instead, owners receive interest payments twice per year.
When an investor purchases a bond, they essentially lend money to the issuer for interest paid over time.
Coupon Bond Rates
The interest rate that a coupon bond pays is typically higher than the face value, which can confuse some investors who are not familiar with this type of investment vehicle.
This high-interest payment is referred to as a “coupon” and represents how much money an investor can expect to receive in interest payments throughout the life of the bond.
For example, if a $1000 coupon bond pays out at a rate of five percent each year until its maturity date, then that means it will pay out $50 every six months over several years.
How To Invest In Coupon Bonds?
There are several ways to invest in coupon bonds, including purchasing them directly from an issuer or buying shares of a fund that invests in these kinds of securities.
If you are considering purchasing coupon bonds directly, it is essential to research the issuer’s creditworthiness before doing so.
Purchasing coupon bonds directly from the issuer is considered riskier than purchasing them through a fund. If something goes wrong with the issuer, you might not receive all of your interest payments.
When To Invest In Coupon Bonds?
Coupon bond rates tend to be higher than interest on bank accounts and other low-risk investments, but they are also riskier because there is no guarantee that coupon bond owners will receive full payment on the face value.
Ideally, investors should purchase coupons when they are at the lowest possible price. This will allow them to make a decent return if interest rates remain stable or fall during the time that it takes for you to receive your money back (which is usually several years).
The Benefits and Risks of Investing in Coupon Bonds
As with any investment, coupon bonds have both benefits and risks.
The main benefit is that you are guaranteed some return on your money as long as the issuer promises to pay their interest payments twice per year.
You also receive this payment in regular intervals throughout the life of the bond instead of all at once upon maturity like most other bonds.
The main risk associated with coupon bonds is that the issuer might default or go bankrupt before they are able to pay you your full principal amount on the bond’s maturity date.
This will leave investors who have not sold their coupons prior to this event at a loss of some or all of their money. As such, it’s important for coupon bond owners to monitor the issuer’s creditworthiness closely.
About the Author
True Tamplin, BSc, CEPF®
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True is a Certified Educator in Personal Finance (CEPF®), contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.