Definition:
A bond issued at a premium occurs when the purchase price of a bond is higher than its face value. This happens when the market interest rate is lower than the coupon rate on the bond. For example, if a bond with a face value of $1,000 is purchased for $1,100, it is said to be issued at a premium of $100.
Key points about bonds issued at a premium:
- Market interest rates: The premium occurs when market interest rates fall after the bond is issued, making the bond’s fixed coupon rate more attractive to investors.
- Amortization: The premium is amortized over the life of the bond, decreasing its carrying value.
- Interest income: The interest income from a bond issued at a premium consists of the coupon payments minus the amortization of the premium.
- Tax implications: The amortization of the premium is treated as a reduction in taxable interest income.
Why are bonds issued at a premium attractive to investors?
- Lower yield: Bonds issued at a premium generally offer a lower yield to maturity compared to bonds issued at par or a discount.
- Stability: Bonds issued at a premium are often considered to be more stable investments, as they are less likely to be called by the issuer.
In essence, a bond issued at a premium is a bond that is purchased for a price above its face value, and it offers investors a lower yield to maturity but may be considered a more stable investment.
