Difference Between Coupon Rate and Required Return (With Table)

The rate of interest paid by the person who issues the bond based on the bond’s face value is called the coupon rate. The periodic interest paid by the person who issues the bond to the buyer is called the coupon rate. The required rate is the minimum amount of return or profit that is received by the investors for taking the responsibility of the security or investing in the stock.

Coupon Rate vs Required Return

The difference between Coupon Rate and Required Return is that coupon rate is the constant value paid by the bond issuer at regular intervals until the bond matures, whereas required return is the amount accepted by the investor for assuming the responsibility of the stock and as an amount of compensation.

The coupon rate is not calculated on the market value. Instead, it is calculated on the bond’s face value. For example, if you have a 5 year Rs 1000 bond that has a coupon rate of 10 per cent, then irrespective of the market value of the bond price, you will receive Rs 100 every year for five years.

To analyze if the investment you commit to is profitable or not, the concept of required return is used. The minimum amount that you would consider to be profitable and worth based on your investment is called required return. If you expect 10 per cent of your investment profitable and beneficial, then that is your required return.

Comparison Table Between Coupon Rate and Required Return

Parameters of ComparisonCoupon RateRequired Return
DefinitionThe coupon rate is the amount of interest that the buyer of the bond will receive annually.     The required return is the percentage of return of bond assuming that the asset is withheld by the investor until the bond matures.
Formula Coupon rate  = ( Total annual payment/par value of bond) * 100                    The required return is calculated by the usage of the beta value.
Variation of the value The coupon rate does not depend on the market value.       It is calculated in accordance with the expected dividend value.
Bond priceThe lesser the value of the coupon rate, the lesser the bond price.    It is more like the compensation price and directly dependent on the risk involved.
RisksWhen the bond matures, if the coupon rate is lesser than that of the invested price, it faces a risk.   It has the risk of investment. A lower return involves lower risk, and a higher investment involves higher risk.    

What is Coupon Rate?

It is the fund that you receive for the fixed time period at regular intervals. Irrespective of the market value, the coupon rate will remain constant. In order to raise the finance and funds to invest in their operations, companies and the government provides the bond.

The coupon rate that your issuer provides periodically is mention in the certificate at the time of issue. It is usually paid to you periodically, either annually or semi-annually. It is similar to the annual interest, which is a constant value, and it is paid for a fixed time of a few years that is based only on the face value of the bond and nothing else.

Until the bond matures, the issuer has to pay the buyer the agreed amount of money. The coupon rate is calculated as the quotient of annual interest divided by the principal amount. For a lot of investors, the yield to maturity rate is much significant and considered while making important decisions.

When the price of the market interest rate is higher than the coupon rate, the price of the bond is most likely to decrease due to that the investors would not wish to purchase the bond at the current purchase value when there is a better possibility. 

What is Required Return?

Risks along with market volatility are important factors to consider while deciding on investing capital. The calculation of the required return is made by considering several factors, including the profit that you might earn and the stock, in addition to the assurance that it is completely risk-free for you.

As an investor, you should consider all the odds and analyze the risks involved before you quote your required return, which is the minimum acceptable and beneficial price. The calculation is wisely done by summing the premium risk involved with the percentage of interest. There are a few factors that affect and have an impact on the required return.

There is a primary risk in which an investor may demand a higher required return for a specific investment that is way too higher and not worth the investment. There are a few cases where the investors fail to demand the right return and end up asking for a low return rate that might affect them and would turn out to be a loss or provide mere profit.

If the investment is not capable of returning profits or funds for a very long period, it consequently increases the risk involved, which adds up to the required rate, which in turn increases the value of the required return. The rate of inflation is also directly proportional to the value of the required return.

Main Differences Between Coupon Rate and Required Return

  1. Coupon Rate is the periodical price that the buyer receives until the bond matures. Required Return is the amount paid for the investor to own the risks.
  2. The coupon rate is calculated using the formula Coupon rate = ( Total annual payment/par value of bond) * 100. Required Return is calculated by using the beta value.
  3. The coupon rate does is independent of the market value. The required return is dependent on the dividend value.
  4. The coupon rate is directly dependent on the bond price, whereas the required return is directly dependent on the risk involved.
  5.  Coupon Rate has a risk on investment due to the fluctuations of the coupon rate. Required Return faces risk due to the price that is invested.          

Conclusion

Especially in capital projects, the required return is significant to decide whether to pursue the project or drop it and pick up another one. In the calculation and analysis of the required return, inflation must also be included. Coupon rate assures guaranteed income securities. It provides the buyer with a regular fixed amount. It applies to bonds and is a safe policy. When the buyer purchases a bond, it pays them regularly irrespective of the market value and hence preferred by many people due to the low risk involved.

References

  1. https://www.jstor.org/stable/2977297
  2. https://www.jstor.org/stable/41862100

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