Let's have a look at the most important coupon types. Between issuance and maturity, the issuer makes regular interest rate payments to the bond investor. The vast majority of bonds are so-called fixed coupon bonds. This means that the coupon is set at bond issuance, for example, at 3%, and does not change over the life of the bond. So in case of a 10 year bond that pays an annual coupon of 3%, the investor knows exactly which interest rate payments will be received and when; assuming, of course, there's no default of the issuer. Another coupon type is the floating coupon. Here, the coupon is not fixed, but determined by a coupon formula that does not change over the life of the bond. And these coupon formulas are often given in the form of LIBOR or a similar reference rate plus minus is spread. This way, the actual interest rate payments are not known in advance as they will depend on future developments of the reference rate. In other words, interest rate payments are variable or floating, and that's why these bonds are often referred to as floating rate nodes or FRN. So if an investor bought, for example, a 10-year floating rate node that pays six months LIBOR, plus 0.5% semi-annually and the first relevant LIBOR fixing is 1.3%, the first interest used to calculate the six months payment is 1.8%. However, as the coupon is only paid for a six months period, so half a year, the actual payment will only be half of that and we are ignoring day count conventions for simplicity here. If now over the next six months, LIBOR will go up, the second coupon will be higher than 1.8%. Should LIBOR decline over the next six months, the second coupon will be lower than 1.8%. A special case of fixed coupon bonds are zero bonds or zero coupon bonds. In case of zeros, there are no interim interest rate payments between issuance of the bond and maturity. So you could also say that they pay a fixed coupon of 0%. However, that of course does not mean that there won't be a return for bond holders. As zero bonds are usually sold at a discounted price, but repaid at a hundred percent at maturity, it is this difference between purchase and redemption price that investors will realize over the life of the bond. In case of our example here, we have a 10 year zero bond that is issued at a price of 74.51%. No interest will be paid over the 10-year term and the bond will be repaid at a hundred percent. So the difference between issue price and redemption price is a total return of the bond holder over the life of the bond.
