What you will learn
- Map coupon rates to actual cash amounts.
- Distinguish face value from the price paid.
Bond
The issuer sets the terms at issue: the face value to be repaid, the coupon paid along the way and the maturity date. Bonds can be traded before maturity, so the market price may sit above or below face value.
Prices usually move opposite to market interest rates: when rates rise, older bonds with lower coupons become less attractive and their prices fall. Bondholders generally rank ahead of shareholders if an issuer fails, yet repayment is never certain. Key risks include interest-rate, credit, inflation and liquidity risk.
Face Value (Par Value)
Face value is set when the bond is issued, and the coupon is calculated on it rather than on the price you pay. Bond prices are commonly quoted as a percentage of face value, so a quote of 98.50 means 98.50% of par.
A price below face value is called a discount, above it a premium. Discounts usually arise when market yields exceed the coupon rate or credit concerns grow; premiums arise in the opposite case. At maturity the issuer owes the face value regardless of the price you paid.
Coupon
For most bonds the coupon rate is fixed at issue, and the annual coupon equals the rate times face value. Payments may be annual, semiannual or quarterly. Floating-rate bonds reset their coupon against a reference rate, while zero-coupon bonds pay none and are issued at a discount.
The coupon rate is not your return, because that also depends on the price paid. Current yield compares the annual coupon with the market price, while yield to maturity also counts the gain or loss between price and face value.
Worked example: Two years of scheduled payments
Illustrative: a bond has HK$1,000 face value, a 4% annual coupon and two years left. Scheduled payments are HK$40 after year one and HK$1,040 after year two. The undiscounted total is HK$1,080. Paying a different market price does not change the contractual cash amounts, but does change the yield implied by that purchase price.
Check your understanding
For HK$5,000 face value at a 3% annual coupon, what is one year’s coupon?
Show answer and explanation
HK$150 = 5,000 × 3%. This is a promised payment, not a guarantee that the issuer will pay or a measure of the total return.