A bond's coupon rate describes the level of interest that it returns within each period. For example, a hundred-dollar bond with a 12 percent coupon that pays annually returns 12 dollars on each coupon date. When the bond allows you to reinvest returns at the coupon rate, the interest compounds, producing further returns. A bond with a set face value, or principal, needs a higher coupon rate to produce the same future value at the time of maturity.
Divide the bond's target future value by its principal. For example, if a $5,000 bond must produce a value of $10,000 over the course of 10 years, divide $10,000 by $5,000, resulting in a multiplier of 2.
Divide 1 by the the number of years until the bond matures. With this example, divide 1 by 10, giving 0.1.
Raise the multiplier from Step 1 to the power of the value from Step 2. Raising 2 to the power of 0.1 gives 1.0718.
Subtract 1 from this value. With this example, this produces 0.0718.
Multiply the result by 100. 0.0718 multiplied by 100 is 7.18. This is the bond's coupon rate.
- The Handbook of Fixed Income Securities; Frank Fabozzi
- The Complete Guide to Investing in Bonds…; Martha Maeda et. al.