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Relationship Between Interest Rate & Bond Prices

A bond's coupon rate is expressed as a percentage of its par value. The par value is simply the face value of the bond or the value of the bond as stated by the issuing entity. Coupon rates are largely influenced by the interest rates set by the government. Anyone looking to sell pre-existing bonds must reduce their market price to compensate investors for the bonds' lower coupon payments relative to the newly issued bonds.

To buy a bond at a premium means to purchase it for more than its par value. To purchase a bond at a discount means paying less than its par value.

Discussion

Regardless of the purchase price, coupon payments remain the same. A bond's yield can be measured in a few different ways. Current yield compares the coupon rate to the current market price of the bond. A more comprehensive measure of a bond's rate of return is its yield to maturity. Since it is possible to generate profit or loss by purchasing bonds below or above par, this yield calculation takes into account the effect of the purchase price on the total rate of return. If a bond's purchase price is equal to its par value, then the coupon rate, current yield, and yield to maturity are the same.

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Coupon Rate and Yield to Maturity

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