Corporate Finance
Professor Mitchell Petersen
Coupon Rates
The coupon rate is set by the firm (with the help of its bankers).
Then the market determines the price it is willing to pay for the bond.
This effectively sets the promised return demanded by the market, since
the present value of the promised payments discounted at the promised rate
is the bond price. Empirically, what coupon rates do firms choose. As part
of his research, Professor
Faulkender has assembled a data base of corporate bond issues between
1990 and 1990 where both the coupon rate and the promised rate are available.
There are 12,551 issues where the coupon rate is positive (i.e. he excluded
zero coupon bonds). Once a firm decides to issue a bond with a positive
coupon rate, the coupon rate is very close to the promised rate demanded
by the market. Remember the bankers are talking to the firm and the market.
Thus all this means is the bankers ask what the market demands and then
they choose to set the coupon rate very close to this level -- and sell
the bond close to par.
In this sample of bond issues the coupon rate and promised rate are
with in one percentage point (i.e. | r_coupon - r_promised | < 1.0%),
for 99.5% of the bond issues. The coupon rate and promised rate are within
20 basis points (0.20%) of each other for 97.2% of the bond issues. The
following graph is the probability distribution of the bond issues by the
absolute difference between the coupon and promised rate (in increments
of 10 basis points). Thus the coupon rate and promised rate are with in
5 basis points for 55% of the sample.
