Coupon rate

A debt security is a contract: the issuer borrows a sum on stated terms. Three terms define it — the principal, the coupon, and the maturity date.

The coupon is the rate of interest the borrower pays the lender, expressed as a percentage of the face value. The face value of a debenture in India is usually Rs 100 or Rs 1,000. The contract also fixes how often it is paid: annually, semi-annually, quarterly or monthly.

The trap is built into the definition. Once a bond starts trading, its price moves, but the coupon does not. A 12 percent bond pays Rs 12 a year on Rs 100 of face value whether it is trading at Rs 90 or Rs 110. So the coupon computes the cash flow and nothing else. To describe the return, the market uses the word yield.

Coupon structures vary, and the workbook names each:

• Fixed rate (plain vanilla) — a pre-defined rate at specified intervals, principal repaid at maturity.
• Floating rate — the rate is reset periodically against a benchmark, such as the RBI repo rate. The workbook's illustration: a 5-year bond reset semi-annually against the 1-year yield on central government securities plus a 50 basis point mark-up. Also called variable rate or adjustable rate bonds.
• Zero coupon — no coupon at all; issued at a discount to face value and redeemed at par, the difference being the implied interest. Issued for a long tenor at a steep discount, it is a deep discount bond.
• Inflation indexed — a floating rate bond whose benchmark is the inflation rate.
• Step-up and deferred interest bonds shift the coupon burden later in the life of the bond.

For the registrar, the coupon rate and its periodicity are what drive the interest payment run: on each interest record date the beneficial owner download is taken, the entitlement is computed per folio, and interest warrants or direct credits go out.

Coupon amount per period = Face value × Coupon rate × (months in period ÷ 12)

Current yield = (Annual coupon ÷ Market price) × 100

The coupon rate sits in the numerator of current yield and nowhere else — the denominator is the price you actually paid.

Take the workbook's own case. A bond pays an annual coupon of 12 percent and trades at Rs 109.50:

Current yield = 12 ÷ 109.50 × 100 = 10.96%

The coupon says 12 percent. The buyer at Rs 109.50 earns 10.96 percent on the money actually committed — and still less on a yield-to-maturity basis, because Rs 109.50 will be redeemed at Rs 100.

Now the registrar's side of the same instrument. An issuer has 20 lakh NCDs of Rs 1,000 face value carrying 8.60 percent payable semi-annually:

Per debenture, per half-year = 1,000 × 8.60% × 6/12 = Rs 43
Total half-yearly outflow    = 20,00,000 × Rs 43    = Rs 8.60 crore

An investor holding 250 NCDs receives 250 × Rs 43 = Rs 10,750 gross every six months — computed off the beneficial owner position as on the record date, not off what the investor holds on the payment date.

Chapter 3.1 (Features of a Debt Security) defines the coupon, and Chapter 3 opens its sample questions with "________ of a bond refers to the interest payable on a bond". Chapter 3.3 then makes the examinable distinction between coupon and yield, with the current yield computation above, and Chapter 3.4 runs through the coupon structures. The paired question — why the coupon is not an indicator of return — recurs constantly.

• The coupon is applied to face value, never to market price. This is the arithmetic error that ruins current-yield questions.
• Coupon ≠ yield. The workbook is explicit: the coupon merely helps compute what cash flows accrue periodically; the return is the yield.
• A zero coupon bond still earns interest. It is embedded in the discount, not paid out periodically.
• A floating rate coupon is reset, not variable within a period. The workbook's example resets every six months and stays put in between.
• Convertible debentures deliberately carry a lower coupon than pure debt, because the investor is also paid in equity upside.
• Government securities have no credit or default risk, so a government coupon and a corporate coupon of the same number are not the same proposition.