The document defines coupon rate as the interest rate stated on a bond, expressed as a percentage of the principal. The coupon rate is used to calculate the periodic interest payments made to bondholders until maturity. There is an inverse relationship between bond prices and interest rates - as interest rates rise, bond prices fall and vice versa. Calculating the yield to maturity accounts for the time value of money and all expected future coupon payments. Key risks for bond investors include interest rate risk, reinvestment risk, and credit/default risk if the bond issuer is unable to repay the debt.

1. Definition
The interest rate stated on a bond, note or other fixed income security, expressed as a
percentage of the principal (face value). also called coupon yield.
A coupon payment on a bond is a periodic interest payment that the bondholder receives during the
time between when the bond is issued and when it matures.
Coupons are normally described in terms of the coupon rate, which is calculated by adding the total
amount of coupons paid per year and dividing by the bond's face value. For example, if a bond has a
face value of $1,000 and a coupon rate of 5%, then it pays total coupons of $50 per year. For the
typical bond, this will consist of semi-annual payments of $25 each.[1]
The coupon rate is the yield that the bond pays on its issue date; however, this yield can change as
the value of the bond changes and thus giving the bond's yield to maturity. Bonds having higher
coupon rates are therefore more desirable for investors than those having lower coupon rates.
Formula
The formula for coupon rate is as follows:
C = i / p
where:
C = coupon rate
i = annualized interest (or coupon)
p = par value of bond
EG If you own at $1,000 bond with a coupon rate of 4%, you will receive interest payments of $40
a yearuntil the bond reaches maturity.
Types of Financial Instruments
Money Market Instruments (Click for more)
The major purpose of financial markets is to transfer funds from lenders to borrowers.
Financial market participants commonly distinguish between the "capital market" and
the "money market". The money market refer to borrowing and lending for periods of a
year or less.
Treasury bills (Click for more)
Treasury bills are short-term securities issued by the U.S. Treasury. The Treasury sells
bills at regularly scheduled auctions to refinance maEagleTraders.comg issues. It also

2. helps to finance current federal deficits. They further sell bills on an irregular basis to
smooth out the uneven flow of revenues from corporate and individual tax receipts.
Certificates of deposit (Click for more)
A certificate of deposit is a document evidencing a time deposit placed with a depository
institution. The following information appears on the certificate:
 the amount of the deposit;
 the date on which it matures;
 the interest rate; and
 the method under which the interest is calculated.
Large negotiable CDs are generally issued in denominations of $1 million or more.
Commercial Paper (Click for more)
Commercial paper is a short-term unsecured promissory note issued by corporations
and foreign governments. It is a low-cost alternative to bank loans, for many large,
credit worthy issuers. Issuers are able to efficiently raise large amounts of funds
quickly and without expensive Securities and Exchange Commission (SEC)
registration. They sell paper, either directly or through independent dealers, to a large
and varied pool of institutional buyers. Investors in commercial paper earn
competitive, market-determined yields in notes whose maturity and amounts can be
tailored to their specific needs.
How are interest rates, bond prices related?
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There is an inverse relationship between bond prices and interestrates.When bond prices go up interest rates
fall and when interest rates rise bond prices fall.
Even though it is clear that bond prices and interest rates are inversely related, there are also many other bond
pricing relationships thatan investor needs to understand.Mentioned below are some pricing relationships between
bonds and interest rates.
 An increase in a bond’s yield to maturity leads to a lesser price decrease than the price increase related with
a decline of equal scale in yield. This is known as convexity.
 Prices of long term bonds are likely to be more perceptive to interestrate amendments than prices ofshort
term bonds.

3.  For coupon bonds,as maturityincreases,the likeliness ofbond prices to change in yield increases ata
declining rate.
 Interestrate risk is inversely related to a bond’s coupon rate.(The sensitivity of a bond’s price to a change in
yield is inversely related to the yield at maturity at which the bond is now selling.)
Let’s explain this with a help of an example
Let’s take the bond price as Rs.100 which pays a rate of interestcalled a coupon.Now, if the interest rates go up, the
bond, in order to pay the same rates, will have to cost less. So, the same bond which was costing Rs.100 may be
priced at Rs.90.
Now, let’s ignore the discount factor where the time frame of a bond is one year giving an interest rate of 4% and
having principle amount as Rs.100. According to 4% rate of interest, the investor gets 4%*100= Rs.4. You pay
Rs.100 for a bond today. At the end of year 1, you receive Rs.4. Now you can buy a new 1 year bond which pays
4.25% on Rs.100 bond.
Thus, you tend to pay less for a bond which will now pay 4.25 % as interest and was originally paying 4% interest.
Now the question is much less are you required to pay.
Today: You Pay X.
Year 1: You Receive Rs4.00
Year 1 (Maturity): You Receive Rs.100
The interest you receive + the difference between the redemption price (Rs.100) and the initial price paid (X) should
give you 4.25%: [(Rs100 - X) + Rs4.00] / X = 4.25%
Rs.104 - X = 4.25% * X
Rs.104 = 4.25% * X + X
Rs.104 = X (4.25% + 1)
Rs.104 / (1.0425) = X
X = Rs 99.76
So, to get a 4.25% yield, you would pay Rs.99.75 for a bond with a 4% coupon.
YTM:-
The rate of returnanticipatedona bondif helduntil the endof itslifetime.YTMisconsideredalong-
termbond yieldexpressedasanannual rate.The YTM calculationtakesintoaccountthe bond’scurrent
marketprice,par value,couponinterestrate andtime tomaturity.Itis alsoassumedthatall coupon
paymentsare reinvestedatthe same rate as the bond’scurrentyield.YTMis a complex butaccurate
calculationof a bond’sreturnthathelpsinvestorscompare bondswithdifferentmaturitiesand
coupons.

4. Yield to maturity accounts for the present value of a bond’s future coupon payments. In other
words, it factors in the time value of money, whereas a simple current yield calculation does not.
An approximate YTM can be found by using a bond yield table. However, because calculating a
bond's YTM is complex and involves trial and error (guessing and checking), it is usually done
by using a business or financial calculator or a computer program.
YTM is the interest rate an investor would earn by investing every coupon payment from the
bond at a constant interest rate until the bond’s maturity date. The present value of all of these
future cash flows equals the bond’s market price. The calculation can be presented as:
Example :- You buy ABC Company bond which matures in 1 year and has a 5% interest rate
(coupon) and has a par value of $100. You pay $90 for the bond.
The current yield is 5.56% (5/90).
If you hold the bond until maturity, ABC Company will pay you $5 as interest and $100 par
value for the matured bond.
Now for your $90 investment, you get $105, so your yield to maturity is 16.67% [= (105/90)-1]
or [=(105-90)/90].
Types of risk in bonds:-
1. InterestRate Risk
Interestratesandbondpricescarry an inverse relationship;asinterestratesfall,the price of
bondstradinginthe marketplace generallyrises.Conversely,wheninterestratesrise,the price
of bondstendstofall.Thishappensbecause wheninterestratesare onthe decline,investorstry
to capture or lock inthe highestratestheycan for as longas theycan. To do this,theywill scoop
up existingbondsthatpaya higherinterestrate thanthe prevailingmarketrate.Thisincrease in
demandtranslatesinto anincrease inbondprice andvice versa
2. Reinvestment Risk
Another danger that bond investors face is reinvestment risk, which is the risk of having
to reinvest proceeds at a lower rate than the funds were previously earning. One of the
main ways this risk presents itself is when interest rates fall over time and callable bonds
are exercised by the issuers.The callable feature allows the issuer to redeem the bond
prior to maturity. As a result, the bondholder receives the principal payment, which is
often at a slight premium to the par value.
3. Credit/DefaultRisk
Whenan investorpurchasesabond,he or she is actuallypurchasingacertificate of debt.Simply
put,thisis borrowedmoneythatmustbe repaidbythe companyovertime withinterest.Many

5. investorsdon'trealize thatcorporate bondsaren'tguaranteedbythe full faithandcredit of the
U.S. government,butinsteaddependonthe corporation'sabilitytorepaythatdebt.