© 2000 John Petroff
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© 2000 John Petroff |
4)- Coupon size
A corporation will set the size of the coupon in consideration of its financial strategy and the investing clientele it wishes to attract. The coupon size can be set for the coupon rate to be higher or lower than the yield on a comparable bond. Note that because all documents, titles and coupons are printed months before the issue, it is most unlikely that the coupon rate will equal any specific target yield because that yield is dependent on market yields on comparable bonds at the time of purchase, as explained in Chapter 3.
a)- The bond will sell at a discount if the coupon rate is lower than the yield. In other words, a small coupon is paid. This means that the bond will appreciate over the life of the bond. The appreciation will be especially large in the beginning (and smaller toward the end). In countries where capital gains receive a preferential tax treatment, this can be especially beneficial for bondholders. At the extreme, bonds have been issued without any coupons, called zero-coupon bonds or zeroes. For the company, selling a bond at a discount implies that it will not receive as much as the nominal or par value suggests. This can be a problem if a given amount was expected and the rise in market yields caused the coupon rate to fall. Over the life of the bond, retiring the bond by refunding would be an attractive strategy because of its low price (but there are tax considerations noted below that limit the appeal of this strategy).
b)- The bond will sell at a premium if the coupon rate is higher than the prevailing yield. Investors will have to pay more than par, but the income from the bond will be higher than on comparable bonds. Large regular income can be important for some bondholders. Thus, the company may target the bond for this type of investor by setting the coupon high and incorporating appropriate protective clauses. For the corporation, a high coupon assures that the proceeds from the issue will be larger than the nominal value. As seen below, a refunding strategy is also available if yields change.
See review questions Q-12D4.1 through Q-12D4.5.
See research assignment R-12D4.1.
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