Coupon Bond: Definition, How They Work, Example, and Use Today

Coupon bonds, also known as bearer bonds or bond coupons, are a type of debt obligation that pays periodic interest payments, typically semiannual, until maturity when the principal is repaid. Here's a detailed analysis of coupon bonds:

1. **Definition and History**: Coupon bonds are rare since most modern bonds are issued electronically, but they were common in the past when bonds were issued in certificate form. The term "coupon" originates from the physical coupons attached to bond certificates that investors would clip and present for interest payments.
2. **How They Work**: Upon issuance, the bond's coupon rate, expressed as a percentage of the face value, is fixed. The issuer pays this rate annually or semiannually. For example, a $1,000 bond with a 5% coupon pays $50 per year, or $25 every six months. The coupon rate is crucial for investors as it determines the yield of the bond.
3. **Calculating the Coupon Rate**: The coupon rate is calculated by dividing the total annual coupon payments by the bond's face value. For instance, a bond with two semiannual coupons of $25 each on a $1,000 face value has a coupon rate of 5%.
4. **Investment Considerations**: Higher coupon rates mean higher yields for investors, making bonds with higher coupons more attractive. However, the value of the bond can fluctuate based on market interest rates, and the coupon rate is fixed until maturity, which can affect the bond's yield if market rates change.
5. **Legal and Regulatory Aspects**: Coupon bonds are often unregistered, meaning that possession of the bond is sufficient to claim interest, which can lead to issues with tax evasion and fraud. Additionally, the legal and regulatory framework for coupon bonds varies by jurisdiction, including specific regulations on issuance and interest rates.

In conclusion, coupon bonds are a traditional form of debt financing that pays periodic interest payments. While they have declined in popularity due to the shift to electronic bonds and the associated risks, they remain an important part of financial history and continue to be used in certain contexts.