Unlike fixed-rate loans, which typically have the same interest rate over the entire period – e.g., 3.5 percent for 20 years – different maturities of bonds in a single bond issue may have different coupon rates. Maturities toward the beginning of the overall term of the bond issue may have lower interest rates than maturities toward the end of the term. For example, a bond maturing within a year may have a 2 percent coupon, while the bond maturing in 20 years may have a 5 percent coupon.
Therefore, with various maturities paying interest at different rates the average coupon is the average interest rate for the entire amount of bonds that were issued. Average coupon is a calculation that expresses total interest cost as a percentage. Average coupon equals the total amount of interest payments to be made divided by the principal amount of bonds that were issued.
Example: A $20,000,000 bond is issued with 20 annual maturities and a different interest rate for each maturity. The total amount of interest that will be paid over the 20 years is calculated to be $1,750,000. The average coupon equals the total interest cost of the bonds divided into the total principal amount of bonds that were issued, or $1,750,000/$20,000,000 = 0.0875, or 8.75%.
