Definition of Stated Interest Rate of a Bond
The stated interest rate of a bond payable is the annual interest rate that is printed on the face of the bond and stated in the related legal document known as the bond indenture. The stated interest rate of a bond payable is also known as the face interest rate, nominal interest rate, contractual interest rate, and the coupon interest rate.
The stated interest rate multiplied by the bond’s face amount (or par amount) determines the amount of cash that must be paid during each year. However, it is common for half of the annual amount to be paid at the end of each 6-month period (semiannually).
Generally, a bond’s stated interest rate is fixed (does not change) for the life of the bond. As a result, the interest payments form an ordinary annuity for the life of the bond. While the interest payments are a constant amount, the market interest rate for the bond is likely to be continually changing. A change in the market interest rate will cause the present value of the interest payments (and the present value of the maturity amount) to change in the opposite direction. For instance, when the market interest rate increases the present value of the existing bond will decrease. When the market interest rate decreases, the present value of an existing bond will increase. (The there can be some limits to the amount of the change.)
Example of a Stated Interest Rate on a Bond
Assume a corporation issues $10,000,000 of bonds having a stated interest rate of 6% and maturing in 10 years. This means that the corporation agrees to pay interest of $300,000 semiannually ($10,000,000 X 6% X 1/2 year) at the end of each of the 20 semiannual periods. At the time the bonds mature (at end of the 10 years) the corporation agrees to also pay $10,000,000. Typically, these cash amounts will not change even if there are significant changes in the market interest rates.
