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 are the tax implications o...0 Views
Finance allah shmoop What are the tax implications of zero
coupon bonds All right well from the investors side you
think that a zero coupon bond would simply have attacks
being paid when the bond and interest payments fully mature
a goal that we hear it shmoop clearly have not
yet achieved That is you buy a zero for half
or two thirds or three force of its par value
and something like that You get no interest or any
payments of any kind along the way for years But
then at the end you get par like three thousand
box or whatever amount of the zero yabba like you
spent two grand and it matures and pars three grand
cause he had three bonds and then you're done well
At that point you pay a tax right and you
think it might be assessed as a long term game
kind of tax because you bought and held it over
a year just like you would have you bought in
equity and held it on five six seven years and
then sold it some gain At that point in an
equity you'd be taxed the long term gains cheaper tax
treatment iaea You know when you sold and turned into
cash but oh so not the case with zero coupon
bonds instead with zero coupon bonds taxes are paid on
the annual imputed maturity of the bond itself such that
if you paid say five hundred bucks for a zero
coupon bond matures with all payments included at a thousand
dollars five years later well you'd be paying tax on
an imputed gain of one hundred bucks a year which
would comprise basically a bundled gain of notional principal gagne
plus whatever imputed interest was included in the bond And
that is tax as ordinary income not long term game
that is you pay the higher tax rate because well
it's a bond and its interest on the bonds you're
paying on so things air re calculated annually And that
hurts So you don't really own anything for more than
a year before uncle sam comes by tio you know
pick your pocket You actually lose cash along the way
with zero coupon bonds and then get a whole bunch
Each of it vomited back to you at the end
On top of everything zeroes are riskier than normal bonds
because they pay nothing along the way and well all
bets iran that they eventually pay off fully at the
end But you know you never know So given everything
you'd better be sure you're getting a big premium for
buying a zero coupon bond over a normal one If
you do some day you want to go in this 00:02:19.8 --> [endTime] direction you know putting your nuts to work
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