What does a bond's coupon rate represent?

The coupon rate of a bond represents the interest rate that the bond issuer agrees to pay to bondholders, expressed as a percentage of the bond's face value. This rate is established at the time the bond is issued and determines the periodic interest payments that the bondholders will receive throughout the life of the bond. For example, if a bond has a face value of $1,000 and a coupon rate of 5%, the bondholder will receive $50 in interest payments each year until the bond matures.

Understanding the coupon rate is crucial for investors, as it influences the bond's attractiveness relative to other investment opportunities and prevailing interest rates. If interest rates rise substantially, existing bonds with lower coupon rates may offer less appeal, potentially leading to a decrease in their market value. Conversely, if new bonds are issued with lower rates, the existing bonds with higher coupon rates can become more valuable. This concept underlines the dynamic nature of bond investing in relation to interest rate movements.