Question

Define coupon and market/effective interest rates as they determine bond pricing at par, premium, or discount values.

Answer 1

Coupon rate is the fixed annual interest paid by the issuer to the bondholder.government and non govt entities issue bonds to raise money to finance their operations.

Coupon rate remains fixed over the lifetime of the bond while the yield to maturity is bound to change.A bond trades at a premium when it offers a coupon rate higher than prevailing interest rates.Discount bond is a bond that is issued at less than its par value or bond is currently trading for less than its par value in the secondary market.

Effective interest rate bond is also known by the name of market interest rate.it is a bond investors yield to maturity.Effective rate of interest is different from that appears on the face of the bond.Market interest rates are likely to increase when bond investors believe that inflation will occur.

Market interest rates are likely to decrease when there is a slow down in economic activity.In this case risk of owing of a bond is reduced.When market interest rates increases then market value of existing bond decreases and vice versa.