Coupon Equivalent Rate - CER
A given bond has a coupon. It pays, say, $60 a year for a $1,000 par bond, or 6 percent. That 6 percent is its coupon.
So then...what's an equivalent rate?
Well, let's say the bond went up to $1,200 par, i.e. the creditworthiness of the issuer got better, and investors bid up that bond's price. It still pays $60 a year, only now that rate is 5% of the $1,200. The new coupon is 5%. So what would be an equivlaent rate? Like...find another bond that pays a coupon, equivalent to that 5%.
And this can get complex in a mathy way, because bonds bought at a discount, for example, not only pay their coupons, but also pay interest along the way.
Say a similar bond fell in price to $800, but paid only 4%. Well, depending on when it came due (let's say it's 5 years from now), not only would investors get its 4% or $40 a year in interest (note that its yield is much higher if investors paid $800 for it), but they'd also get an appreciation of the bond of $200 / 5 year = $40 a year in addition to the coupon or interest.
So this concept basically equates other factors in bond calculation to try and dial in the real total coupon, keeping apples being compared with other apples, and not kumquats or prunes or something.
Equivalency. Just Shmoop it.
Related or Semi-related Video
Finance: What is a zero coupon bond?13 Views
Finance allah shmoop What is a zero coupon bond After
all this time our hero remains zero Yeah dude all
right well there was a whole song about him and
your parentsgeneration Just ask him The coupon on a bond
is its dividend or yield payment also known as the
rent paid by the corporation or government or individual who's
Borrowing that money sofa bond has zero coupon Does that
mean the rental of that capital is free Uh no
not at all Isiro coupon bond with par value of
a thousand might sell initially for say seven hundred twenty
dollars iy a big discount to that grand the bonds
interest is on ly paid cumulatively at the very end
when the person who loaned the seven hundred twenty dollars
gets his grand back that's it it's a one time
payment of a thousand bucks so many years later like
a decade of that bond yielding a bit over three
point three percent if you did the math of compounding
well this is what it would look like Note that
the amount owed at the end of the year is
mohr than what was owed the previous year and that
the interest is charged than on that amount Well in
real life these calculations are done twice a year with
bonds that is every six months the interest rates are
charged Zero coupon bonds yield notably more than normal bonds
which pay interests every six months Why Why With zero
coupon bonds yield mohr risk in paying some interest at
least some each six month period Well the bondholders getting
something back along the way and over time the interest
payments can be More than the principal loaned itself So
with zero coupon bonds Well there's Just a one time
payment at the very end So you'd better hope the
person showing you that money doesn't You know just decide
to skip town a week before the principal and interest
combined Or do speaking of which i've got a flight 00:02:00.288 --> [endTime] to catch No
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