How is Interest Calculated?

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Interest is a periodic payment an investor receives from an issuer to allow the issuer to borrow the face amount of the security. 

Calculating Interest For Municipal Securities

Securities, such as municipal bonds and mortgages, have interest payments associated with them.

Issuers begin paying interest to the investor on the first interest payment date and finish paying them on the maturity date. A security’s cash flow is the combination of all the interest payments throughout the life of the security and the security’s face amount repaid on the maturity date.

The security borrowed, excluding zero-coupon bonds, has an annual coupon rate associated with it. The annual coupon rate defines the interest amount paid by the issuer to the investor over a year period.

On every interest payment date, the investor receives a payment equal to the face amount of the security multiplied by the coupon rate divided by the number of interest payments they will be receiving over a year period. Here is the formula:

A security has a $10,000,000 face amount and a 5.00% annual coupon rate. Its dated/delivery date is 02/02/2022, and its first interest payment date is 05/01/2022. It pays interest twice a year, on May 1 and November 1. It matures on 11/01/2030.
The first interest payment will only be $125,000 since the first interest payment date is three months away instead of six. After that, each semi-annual payment will be $250,000. This is calculated by dividing the 5.00% interest rate by two annual payments and multiplying that result by the $10,000,000 face amount.

What’s important here?

To calculate the annual interest payment, you can simply multiply the face value of the security by its annual coupon rate.

If the security pays out more frequently than once per year, you can find the periodic interest payment by dividing the coupon rate by the number of payments in a year and then multiplying by the face amount.