Difference Between Coupon Rate vs Interest Rate

What is Coupon Rate?

The coupon rateCoupon RateThe coupon rate is the ROI (rate of interest) paid on the bond’s face value by the bond’s issuers. It determines the repayment amount made by GIS (guaranteed income security). Coupon Rate = Annualized Interest Payment / Par Value of Bond * 100%read more is the rate of interest being paid off for the fixed income security such as bonds. This interest is paid by the bond issuers where it is being calculated annually on the bonds face value, and it is being paid to the purchasers. Usually, the coupon rate is calculated by dividing the sum of coupon payments by the face value of a bond. Bonds are issued by government and companies in order to raise capital to finance their operations. So, the coupon rate is the amount of yield paid by the issuer to their purchasers, but it is a certain percentage amount calculated on the face value.

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What is Interest Rate?

The interest rate is the amount charged by the lender from the borrower, which is calculated annually on the amount that has been lent. The interest rates are being affected by the change in the market scenario. The interest rate does not depend on the issue price or market value; it is already being decided by the issuing party. The market interest rates have effects on the bond prices and yield, wherein the increase in the market interest rates will reduce the fixed-rates of the bond.

Coupon Rate vs. Interest Rate Infographics

Here we provide you with the top 8 difference between Coupon Rate vs. Interest Rate.

Coupon Rate vs. Interest Rate – Key Differences

The key differences between Coupon Rate vs. Interest Rate are as follows –

  • The coupon rate is calculated on the face value of the bondValue Of The BondBonds refer to the debt instruments issued by governments or corporations to acquire investors’ funds for a certain period.read more, which is being invested. The interest rate is calculated considering the basis of the riskiness of lending the amount to the borrower.The coupon rate is decided by the issuer of the bonds to the purchaser. The interest rate is decided by the lender.Coupon rates are largely affected by the interest rates decided by the government. If the interest rates are set to 6%, then no investor will accept the bonds offering coupon rate lower than this. Interest rates are decided and controlled by the government and are dependent on the market conditions.Consider two bonds with all characteristics similar apart from the coupon rates. The bond with lower coupon rates will have a greater decrease in value when the interest rate rises. Bonds with low coupon rates will have higher interest rate riskHigher Interest Rate RiskThe risk of an asset’s value changing due to interest rate volatility is known as interest rate risk. It either makes the security non-competitive or makes it more valuable. read more than bonds that have higher coupon rates.For example, consider a bond with a coupon rate of 2% and another bond with a coupon rate of 4%. Keeping all the features the same, bond with a 2% coupon rate will fall more than the bond with a 4% coupon rate.Maturity affects interest rate risk. The longer the bank’s maturity, the higher the chances of it being affected by the changes interest rate prior to maturity. This may have a negative effect on the price of the bond. Longer maturity will have a higher interest rate risk, while shorter maturity will have a lower interest rate risk.To compensate for this high-interest rate risk, bonds generally offer a high coupon rate for high-interest rates and longer maturity bonds. Similarly, shorter maturity bonds will have a lower interest rate risk and a lower coupon rate.If the investor purchases a bond of 10 years, of the face value of $1,000, and a coupon rate of 10 percent, then the bond purchaser gets $100 every year as coupon payments on the bond. If a bank has lent $ 1000 to a customer and the interest rate is 12 percent, then the borrower will have to pay charges $120 per year.

Coupon Rate vs. Interest Rate Head to Head Difference

Let’s now look at the head to head difference between Coupon Rate vs. Interest Rate.

Final Thought

If the investor intends to hold the bond to maturity, the day-to-day fluctuations in the bond price may not be that important. The bond priceBond PriceThe bond pricing formula calculates the present value of the probable future cash flows, which include coupon payments and the par value, which is the redemption amount at maturity. The yield to maturity (YTM) refers to the rate of interest used to discount future cash flows.read more will change, but the stated interest rate will be received. On the other hand, instead of holding the bonds until maturity, the investor can sell the bond and reinvest the money or the proceeds into another bond that pays a higher coupon rate.

This has been a guide to the Coupon Rate vs. Interest Rate. Here we discuss the top differences between Coupon Rate vs. Interest Rate along with infographics and a comparison table. You may also have a look at the following articles –

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