A coupon bond is a type of fixed-income security issued with detachable coupons. These coupons must be presented to a paying agent or the bond issuer for semiannual interest payments. Since coupon bonds are a form of bearer bond, the person who physically holds the bond certificate or coupon is entitled to receive the interest payments and, ultimately, the principal repayment when the bond matures.
Characteristics of Coupon Bonds
Detachable Coupons
The defining feature of coupon bonds is the detachable coupons attached to the bond certificate. Each coupon represents an interest payment due on the bond’s specified dates, typically every six months.
Bearer Form
Coupon bonds are bearer bonds, meaning possession of the physical bond certificate (or coupon) is proof of ownership and the right to claim interest payments. There is no registration of ownership, so information about the bondholder is not maintained by the issuer.
Fixed Interest Payments
Coupon bonds come with fixed interest rates paid periodically. These rates are known and decided at the time of issuance and remain unchanged over the bond’s life.
Special Considerations
Security Risks
Bearer bonds, including coupon bonds, carry heightened security risks because they can be lost or stolen. Possession dictates entitlement, so these instruments can be misappropriated easily.
Decline in Popularity
Due to their anonymous nature, coupon bonds have seen a decline in issuance and popularity. Regulations and anti-money laundering (AML) laws have largely favored registered bonds, which track and record bondholder information.
Example
Imagine a bond certificate with ten coupons attached, each one representing an interest payment due over a five-year period (two payments per year). If the bondholder presents one coupon every six months, they receive the interest as stipulated.
Historical Context
Coupon bonds were more common in the past, particularly before the advent of electronic record-keeping and the enforcement of stricter financial regulations. They were convenient in a paper-based financial system but are considered outdated in the modern digital era.
Applicability
Coupon bonds are useful primarily as an educational example of historical financial instruments. Most investors and institutions today prefer registered bonds due to the security and traceability they offer.
Tax Implications
Holders of coupon bonds must declare the interest income received from these bonds, which is subject to taxation. Since ownership is based on possession, ensuring proper record-keeping for tax purposes is the responsibility of the individual bondholder.
Comparison with Registered Bonds
- Ownership Tracking: Registered bonds keep records of ownership and transfer through issuers or registrars, unlike the anonymous nature of coupon bonds.
- Security: Registered bonds offer more security since they cannot be lost or stolen in the same way as coupon bonds.
- Interest Payments: Registered bonds typically have interest payments sent directly to the bondholder’s registered address or bank account.
Related Terms
- Bearer Bond: A bond not registered in the owner’s name and is payable to the holder.
- Registered Bond: A bond whose ownership is recorded by the issuer, providing more security and easier transfer of ownership.
Frequently Asked Questions
What is the main disadvantage of a coupon bond?
The principal disadvantage is the risk of loss or theft, as physical possession of the bond is critical to claiming interest payments and the principal.
Why are coupon bonds no longer popular?
Due to advancements in electronic record-keeping and regulatory changes, modern finance favors registered bonds, which offer greater security and traceability.
How often are interest payments made on coupon bonds?
Interest payments are typically made semiannually (every six months).
References
- Brigham, E. F., & Houston, J. F. (2018). Fundamentals of Financial Management. Cengage Learning.
- Fabozzi, F. J. (2012). Bond Markets, Analysis, and Strategies. Pearson Education.
Summary
Coupon bonds are historical fixed-income securities characterized by detachable coupons redeemable for semiannual interest payments. As bearer bonds, they are prone to loss and theft and have seen a decline due to secure and traceable alternatives like registered bonds. Understanding coupon bonds aids in comprehending the evolution of financial instruments and their regulatory environment.
