By Christopher R. Morgan
The coupon rate and the effect it has on the liquidity, market value and any optionality of a fixed-income security is an integral, but often overlooked, part of pre-purchase analysis. There are several ways to mitigate the amount of loss when rates inevitably rise: increase cash holdings, purchase short-term and/or floating-rate bonds and buy high-coupon “cushion” bonds. The latter can be a bit of a shock for some, as a higher coupon is accompanied by a higher price, but in a rising rate environment a high-coupon bond will lose less and provide income above the prevailing market rates. Simply said, higher-coupon bonds hold their value in a rising-rate environment better than the near-par and discounted price alternatives. High-coupon bonds (also referred to as kickers, cushion bonds, premiums or rate shields) will provide greater cash flow that will allow investors to repurchase securities at lower prices (higher yields) and mitigate losses as rates eventually increase.