What is the diffrence between the coupon rate and market rate of interest on a bond or mortgage?
Answers:
Coupon Rate is the stated rate that you get on the bond/mortgage.
The Market Rate is the current going rate for that same instrument.
Let's say I bought a stated 5% (coupon rate) bond 30 days ago and the same bond if new today would go for 6 % (market rate). There is your difference between the 2 types of rates.
the coupon rate is the percentage of the par value of the bond that is paid to the holder every year until maturity. The coupon rate is set when the bonds are issued and remain the same.
The market rate of return fluctuates, with fed funds decisions, the rate of inflation, etc. The rate of return that you could currently receive.
Let's say you bought a 5% Treasury bond in the original gov. auction for exactly $100 per bond. Then you get exactly a 5% yield.
Now suppose that 6 months later the market is more worried about inflation and the Federal Reserve has raised interest rates; and you want to sell the bond on the open market. You may only get $90 per bond. Then the buyer of your bond is now getting a yield of (100/90)*5% = 5.56%
The bond still pays out $5 per year, but the buyer didn't pay $100 for the bond. Because he paid less, his effective yield is higher.
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