Coupon Rate vs Required Return: Difference and Comparison

The interest rate 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 gives the bond to the buyer is called the coupon rate.

The required rate is the minimum return or profits the investors receive for taking responsibility for the security or investing in the stock.

Key Takeaways

1. The coupon rate is the interest rate paid by a bond issuer to its bondholders, while the required return is the minimum return expected by investors.
2. The coupon rate is fixed and does not change over the bond’s life, while the required return changes depending on market conditions.
3. The coupon rate is used to calculate a bond’s interest payments, while the required return is used to evaluate the investment potential of a bond.

Coupon Rate vs Required Return

The Coupon Rate is the interest paid on a bond expressed as a percentage of its face value. For example, a bond with a coupon rate of 5% and a face value of $100 will pay $5 annual interest. The Required Return is the minimum return an investor expects to receive from an investment. It represents the risk associated with the investment and the minimum return the investor requires to compensate for the opportunity cost of investing in that particular security.

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 with 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.

The concept of required return is used to analyze whether the investment you commit to is profitable. The required return is the minimum amount you consider profitable and worth based on your investment.

That is your required return if you expect 10% of your investment to be profitable and beneficial.

Comparison Table

Parameters of Comparison	Coupon Rate	Required Return
Definition	The coupon rate is the interest the bond buyer will receive annually.	The required return is the percentage of return of the bond, assuming that the investor withholds the asset until the bond matures.
Formula	Coupon rate  = ( Total annual payment/par value of bond) * 100	The usage of the beta value calculates the required return.
Variation of the value	The coupon rate does not depend on the market value.	The expected dividend value calculates it.
Bond price	The lesser the value of the coupon rate, the lesser the bond price.	It is more like the compensation price and depends on the risk involved.
Risks	When the bond matures, it faces a risk if the coupon rate is lesser than the invested price.	It has the risk of investment. A lower return involves lower risk, and a higher investment involves higher risk.

What is Coupon Rate?

You receive a fund for a fixed period at regular intervals. Irrespective of the market value, the coupon rate will remain constant. Companies and the government provide the bond to raise the finance and funds to invest in their operations.

The coupon rate your issuer provides periodically is mentioned in the certificate at the time of issue. It is 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 based only on the face value of the bond and nothing else.

The issuer must pay the buyer the agreed amount until the bond matures. The coupon rate is calculated as the quotient of annual interest divided by the principal amount. For many investors, the yield-to-maturity rate is much more significant and considered while making important decisions.

When the market interest rate is higher than the coupon rate, the bond price is most likely to decrease because 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 and market volatility are essential when deciding on investing capital. The required return is calculated by considering several factors, including the profit you might earn and the stock and the assurance that it is entirely risk-free.

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.

In a few cases, the investors fail to demand the correct return and end up asking for a low return rate that might affect them and be a loss or provide mere profit.

If the investment cannot return profits or funds for a very long period, it consequently increases the risk involved, which adds up to the required rate, increasing the value of the required return.

The inflation rate is also directly proportional to the required return value.

Main Differences Between Coupon Rate and Required Return

1. The coupon Rate is the regular price 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. The required Return is calculated by using the beta value.
3. The coupon rate is independent of the market value. The required return is dependent on the dividend value.
4. The coupon rate depends on the bond price, whereas the required return now depends 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.          

References

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

Last Updated : 13 July, 2023