What Is the Cum Coupon Method?
Cum coupon is a method of trading bonds used in the United States and many other developed nations which allows the buyer of the bond to collect the next interest payment. The interest payment is dependent upon the coupon rate of the bond, which is why such a bond is said to be traded cum, or with, coupon. When a bond is traded cum coupon, the buyer must pay any accrued interest from the previous coupon payment to the time of purchase to the seller. If a bond is traded without the next interest payment attached to it, it is being traded ex coupon.
Bonds are used by institutions to raise money, while they provide investors the opportunity to receive fixed income over time. The basic bond transaction requires investors to purchase the bonds with a principal payment. During the term of the bond agreement, investors also receive interest payments at a percentage known as the coupon rate. At the end of the bond term, also known as its maturity, the bondholder receives the return of the principal. Most coupons that are resold by the original buyer are traded in the cum coupon method.
A bond is often traded cum coupon when it changes hands on the secondary market. The secondary market for bonds takes place when the original buyers of bonds put them up for sale. New buyers step in and pay a price to begin receiving interest payments on the bonds.
When a bond is traded on the secondary market in between interest payments, the seller must receive some recompense for the time he or she has owned the bond between the previous interest payment and the time of selling. This amount is known as the accrued interest, and the buyer is required to pay this interest along with the purchase price. Most secondary market bonds are cum coupon bonds, which means that the buyer, after paying the accrued interest to the seller, gets the benefit of the next interest payment.
Since most bonds in the U.S. and other major markets, are traded via the cum coupon method, the prices for bonds reflect the knowledge that buyers on the secondary market will have the next interest payment coming to them. There are certain bonds on the secondary market that do not give the new buyer the right to the next interest payment. These are ex coupon bonds, and they are generally traded at a discount to their counterparts with coupons attached.
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