Coupon Bonds Formula
Coupon bonds are bonds which pay a specific interest rate, but what is the formula that will allow you to determine what the coupon payment should be? These bonds are named so because they originally started out with coupons attached, one for each payment. Unlike Treasury bills, which sell for a discounted price and do not pay interest until maturity, bonds usually offer a set amount of interest at purchase. Coupon bonds may involve varying interest rates, depending on when the bond was issued and who issued it. The front of the bond will have all of the information you need to determine what your annual or semi-annual payment will be.
Premium bonds are bonds which have an interest rate higher than average when the bonds are offered. These bonds will usually involve a higher cost, because of the higher return. Coupon bonds may also sell at discount, and this occurs when the bond interest rate is lower than average when the bond is sold. Investors will pay less if a bond is at discount, because of the lower return due to the lower than normal rate. Zero coupon bonds do not pay interest, and instead are sold at a discounted price compared to the face value of the bond.
The formula for figuring out the total return for coupon bonds follows a complex formula, and involves an estimated present value for a bond. All of the individual coupon payments are added together with the face value of the bond at maturity, and then the cost of the purchase price for the bond is deducted. Zero coupon municipal bonds are often preferred because these bonds do not require any formula which involves many different steps. This formula also takes into account whether the bond was purchased at par, at discount, or at premium.