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Fixed Coupon Structures

A bond’s coupon payment is the periodic interest payment that the issuer promises to pay the holder. A coupon can be structured in numerous ways. Below are the most common coupon structures:

Annual Coupon Payments: Most bonds outside of the United States pay coupon interest once per year. For example, the issuer of a European bond with an 8% coupon rate and a $10,000 face value will make one annual interest payment of $800 to the holder of the bond.

Year¹ Year² Year³… Year^mat
$800 + $800 + $800 + $10,800

Semi-Annual Coupon Payments: The majority of bonds issued in the United States by domestic entities pay interest every six months. For example, a 30 Year U.S. government bond with a $1,000 face value and a 5% coupon rate will make a $25 interest payment every six months until maturity. Alternatively, an 8% coupon bond with a $10,000 face value will make semi-annual interest payments of $400 as detailed below:

6 Months¹ 6 Months² 6 Months³… 6 Months^Mat
$400 + $400 + $400 + $10,400

Zero-Coupon Bonds: A zero-coupon bond (also known as a discount bond) does not make periodic interest payments during its lifespan. Instead, the issuer of a zero-coupon bond makes a single principal payment to the holder at maturity. Zero-Coupon bonds are issued at significant discounts to face value. As a zero-coupon bond reaches maturity, its market value will approach its par value. Below is an example of the payment structure of a zero coupon:

Period¹ Period² Period³ … Maturity^Mat
$0 + $0 + $0 + $10,000

Accrual Bonds: An Accrual bond is similar to a zero-coupon bond in that it does not make periodic interest payments during its lifespan. Instead, the issuer of an accrual bond makes a single compounded interest payment plus the principal payment at maturity. Because accrual bonds repay interest and principal at maturity, they often sell for a premium over par in the market place.

Period¹ Period² Period³ … Maturity^Mat
$0 + $0 + $0 + $12,440

The maturity payment of $14,440 includes the principal amount plus all compounded interest.

Practice Questions:

1. Calculate the coupon payment of a ten year $1,000 par value bond that pays an annual coupon of 6%.

   a. $60
   b. $50
   c. $120
   d. $30

2. Calculate the coupon payment of a ten year $10,000 par value bond that pays a semi-annual coupon and has a coupon rate of 10%.

   a. $1,000
   b. $5,000
   c. $100
   d. $500

3. Calculate the coupon payments of 30 ten year $1,000 par value bonds with semi-annual coupons of 7.5%.

   a. $37.50
   b. $112.50
   c. $1,125.00
   d. $2,250.00

Answers:

1. A

2. D

3. C