Before starting off the article, one thing has to be made clear here, that the coupon rate is totally different from the interest rate. A coupon rate is an annual interest payment, which is provided by the bond issuer to the bondholder at the time of maturity. In the meantime, coming to the interest rate, it is the charges put on the payment by the lender to the borrower.
Coupon Rate vs Interest Rate
The main difference between Coupon Rate and Interest Rate is that the coupon rate has a fixed rate throughout the life of the bond. Meanwhile, the interest rate changes its rate according to the bond yields.
The coupon rate is the annual rate of the bond that has to be paid to the holder. Also, it depends on the par value, that is, the face value of the band during the issue period. Following that, there would be no changes to the payment, as the rate is fixed completely till the expiry of the bond.
On the other hand, the interest rate is the money to be added by the lender to extract the lent money from the borrower. The payment will be increasing as per the interest rate put on by the lender. Unlike the coupon rate, the interest rate might change its value every period.
Comparison Table Between Coupon Rate and Interest Rate
| Parameters of Comparison | Coupon Rate | Interest Rate |
| Meaning | A coupon rate is an annual interest payment received by the bondholder on the bonds after the maturity period comes to an end. Coupon rates are issued on fixed-income security such as bonds, mortgage, securities etc. | Interest rate is charged to the borrower by the lender in case of any borrowing or lease happening. |
| Face value | Face values are determined by the nominal value of the security or bonds. | Face value of Interest rate is dissuaded as the amount of a debt precluding by the borrower. |
| Maturity period | A coupon rate is a fixed payment of the bond, and the maturity period is issued by the holder at the initial stage of issuing the bond. It varies according to the bondholders of the bond—for instance, a 5-year bond period. | Borrowers are asked to pay back the amount they have borrowed within a specific period, which consists of an interest rate per annum. For example, she/he borrowed money based on ten years, then within ten years, he/she asked to settle with a specific interest rate. |
| Other names | Coupon rates are also termed as Yield rate and Nominal yield. | Interest rate is also known as borrowing rate, rate of interest, prime rate, cost of money and bank rate. |
| Calculation | Coupon Rate= Coupon value/ Par value | Two methods- simple interest and compound interest rate.SI=Principal amount x Rate of interest x Time period CI= Principal x (1+Rate of interest) |
| Types of Coupon Rate | Zero-coupon bonds(no changes in coupon rate), step-up bonds(increase coupon rate) andfloating- coupon rate(fluctuation) securities. | Nominal interest rate, effective rate and real interest rate. |
What is Coupon Rate?
The coupon rate is also known as the nominal rate. It is defined by the fixed interest secrets of the bondholder. The final amount will be received by the holder at the end of the maturity period. Additionally, the coupon rate will be stable till the bondholder receives his money. And the holder has to pay every year till the maturity of the bond reaches.
Having that said; theoretically, the coupon rate is calculated by dividing the total amount of annual payments made by a bond with the face value of the bond initially.
There are three types of coupon rates depending on their fixed-income securities.
Firstly, it is the zero-coupon bonds. They don’t have any coupon payment for the bondholder to pay for. Also, it is affordable by the holder at a price lesser than the original par value of the bond. Secondly, Step-Up notes, unlike the true definition of a coupon rate, tend to increase the rate at a set period. Lastly, floating-rate securities depend on the reference rate of the coupons.
What is Interest Rate?
On the other hand, it is also known as the annual percentage. The interest rate refers to the money plus interests that have to be paid by the holder to the lender. The final amount of the bond that has to be paid by the borrower depends on the bond’s principal sum, the interest rate, and the span over which it is taken.
The change in the rate varies every month or day. It is due to the short-term political gain, risks of investments, taxes, banks, and so on.
The interest rate has two formulae contributing to simple interest and compound interest.
The simple interest is calculated by multiplying the principal amount with the annual interest rate and term of the loan over the years.
Meanwhile, compound interest is by multiplying principal amount with (1+ annual rate interest) and term of the loan in years. The maturity period will end when the interest is completely paid by the borrower to the bond’s lender.
Main Differences Between Coupon Rate and Interest Rate
- Coupon rates are calculated on the fixed-income security, whereas interest rates are calculated on the amount which has been lent to borrowers.
- The coupon’s face value determines the nominal value of the bond. Albeit the Interest rate’s face value affected by the amount due on.
- The coupon rate follows a formula to calculate the rate. In contrast, the Interest rate follows two methods to sum the rate value-simple interest and compound interest method.
- The rates of a coupon vary according to the types of coupon such as Zero, Step-up and Floating coupon rate. The interest rate has three types as Nominal, Effective and real interest rate.
- In the case of coupon rate, the bondholder already mentioned the maturity while issuing for the bond, but in interest rate- the maturity period ends only if the amount is full-settled by the borrower.
Conclusion
The coupon rate is normally used in the bonds, which is an income to the holder after paying the rate on certain purchased items. Interest rate is a reduction to the borrower by paying back the amount he/she has borrowed.
The coupon Rate ends according to the maturity period mentioned by the bondholder while issuing the bond. But in interest rate, maturity ends only if the lent amount is fully paid by the Borrower.
References
- https://books.google.co.in/books?hl=en&lr=&id=ytT-W8_KL-AC&oi=fnd&pg=PA199&dq=meaning+coupon+rate&ots=W6ayPGouqC&sig=HUZTesNjN5O6NQgbCwepYLTo79A
- https://books.google.co.in/books?hl=en&lr=&id=C31l_fs-mMkC&oi=fnd&pg=PR7&dq=meaning+interest+rate&ots=E-LcncoaGi&sig=dhPkG0VCDKGaIs_KNsAR-coT3Ws