Show the relationship between required rate of return and coupon rate on the value of a bond?


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Alex Wheeler answered
The coupon rate's relationship to the rate of return of a bond is inverted i.e. A lower coupon rate means the bond is being sold at a discount, whilst a higher coupon rate means the bond is being sold for more than its face value.

  • What is a bond?
A bond is a financial tool which represents a money loan. The bond usually comes with conditions of repayment, including interest to be paid at certain times, and a repayment date. The person issuing the bond is the debtor, and the person holding it is the creditor. The interest is known as the 'coupon', and the date the repayment must be made by is termed as the bond's 'maturity'. Bonds are usually issued to cover costs of improving businesses or investments, and are a legal contract of a loan.

There are several types of bond. Some examples are:
  • Fixed rate bonds: The coupon rate of these bonds is fixed for the bond's full term, meaning the rate of return is also fixed.
  • Zero-coupon bonds: As the name suggests, these are bonds which have no interest rate at all.
  • Inflation linked bonds: This type of bond has its coupon rate directly linked to the rate of inflation in the country is it issued in.

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