Kenneth R. Szulczyk

discount bond for $15,000 that has a face value of $20,000 with a three-year maturity. We
calculate your annual rate of return of 10.1% in Equation 2. Did you notice the time subscript is
a three?

 

 

 

0. 101

1. 333333 1

15,000

20000

1

1

20000

15,000

1

3

3

3

3

3

YTM=

YTM

$

$ ,

+YTM =

+YTM

$ ,

$ =

+YTM

FV

PV 0 =

 

( 2 )

A coupon bond differs from a discount bond because its interest rate is stated on the
certificate. During the old days, an investor would detach a coupon from the bond and mail it to
the corporation or government for an interest payment. Then the corporation or government
would send a check to the bondholder. We show a coupon bond in Figure 3 with dated coupons
at the bottom of the certificate.

Treasury Note

U.S. Government

$20,000

10%

August 10, 2020

Figure 3. An example of a coupon bond

This coupon bond is a U.S. Treasury note with a face value of $20,000, or T-note for short.
Moreover, U.S. government pays 10% interest every six months; consequently, the person who
possesses this instrument would clip off one coupon and send it to the U.S. federal government
for payment. Hence, the interest payment equals 0.1 × $20,000 × 0.5 = $1,000 for every six
months. When the T-note matures on August 10, 2020, the bondholder receives $20,000.
Market interest rate rarely equals the bond’s stated interest rate. If the market interest rate is
lower than the coupon interest rate, then a corporation or government would never sell the bond
for the face value because it would pay a higher interest rate than the marker. However, the