Coupon

Anyone who borrows money usually pays interest for it. States and large corporations do not borrow money only from banks, but also from many investors at the same time. To do this, they issue debt certificates called bonds, which can be bought and resold. The coupon is the interest amount that the debtor pays out regularly to the holders of these debt certificates. It is stated as a percentage of the printed amount, usually paid once or twice a year. The name comes from a time when bonds were still made of paper: small slips were attached to the edge, which could be cut off and exchanged for money at the bank.

What the coupon reveals about trust

The size of the coupon is no coincidence. It shows the terms under which a debtor can get money in the market at all. A state that everyone trusts to repay its debts gets away with a low coupon. A company with a shaky balance sheet has to offer significantly more, or nobody will buy. That is why journalists often refer to high-coupon bonds as junk bonds.

For investors, the coupon is also a predictable source of income. Unlike a share, whose dividend can be cut or scrapped, the coupon payment is contractually guaranteed. If it fails to materialize, that constitutes a default with serious legal consequences. It is precisely this reliability that makes bonds attractive to insurance companies and pension funds, which have to make fixed payouts over decades.

At the same time, a high coupon is never a gift. It is compensation for risk. Anyone who collects a nine percent coupon bears a real chance of never seeing their invested money again.

Distinguishing between coupon, price, and yield

The coupon always relates to the face value, that is, the printed amount of the bond. With a face value of 1,000 euros and a coupon of three percent, 30 euros are paid out every year. This amount is stipulated in the contract and remains the same for most bonds until repayment. At the end of the term, the holder additionally receives the 1,000 euros back.

The price of the bond on the stock exchange, by contrast, fluctuates constantly. If general interest rates rise, older bonds with a low coupon appear unattractive. Their price falls until the fixed coupon amount becomes competitive again relative to the lower purchase price. If interest rates fall, the opposite happens and prices rise.

This gives rise to the most important distinction in this topic. The coupon is fixed, the yield is not. Yield refers to the actual return, calculated on the price actually paid. Anyone who buys the bond mentioned above for 900 euros still receives a 30-euro coupon, but thereby achieves a yield of just over 3.3 percent. There are also bonds with no coupon at all, so-called zero-coupon bonds. They are sold below face value, and the profit arises solely upon repayment.

Coupons in market news and in the portfolio

In financial news, the term usually appears in connection with new issues. For example, it might be reported that a corporation has issued a bond worth 500 million euros with a coupon of 4.25 percent. This figure reveals how expensive debt currently is for this company. Comparing it with previous issues immediately shows whether financing costs have risen.

The word also comes up in connection with central banks. If the European Central Bank raises its key interest rates, new bonds have to offer higher coupons. Older securities in a portfolio then lose market value, even though their interest payment continues unchanged. This very effect caused losses in many bond funds, that is, funds that hold predominantly bonds, in 2022.

A common misconception is that a high coupon automatically means a good deal. What matters is always what one pays for the bond and how secure the debtor is. Anyone investing on their own will find the coupon in the securities prospectus and in every portfolio overview. There, the payment appears as a regular incoming payment, usually on a fixed date each year.