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What Does It Mean When a Bond Is Selling at a Premium? Is It a Good Investment?

source : investopedia.com

What Does It Mean When a Bond Is Selling at a Premium? Is It a Good Investment?

When the terms premium and discount are used in reference to bonds, they are telling investors that the purchase price of the bond is either above or below its par value.

For example, a bond with a par value of 1,000 is selling at a premium when it can be bought for more than 1,000 and is selling at a discount when it can be bought for less than 1,000.

Bonds can be sold for more and less than their par values because of changing interest rates. Like most fixed-income securities, bonds are highly correlated to interest rates. When interest rates go up, a bond’s market price will fall and vice versa.

Are Bonds Selling At A Premium A Good Investment?

To better explain this, let’s look at an example. Imagine the market interest rate is 3% today and you just purchased a bond paying a 5% coupon with a face value of 1,000. If interest rates go down by 1% from the time of your purchase, you will be able to sell the bond for a profit (or a premium). This is because the bond is now paying more than the market rate (because the coupon is 5%).

The spread used to be 2% (5% – 3%), but it’s now increased to 3% (5% – 2%). This is a simplified way of looking at a bond’s price, as many other factors are involved; however, it does show the general relationship between bonds and interest rates.

As for the attractiveness of the investment, you can’t determine whether a bond is a good investment solely based on whether it is selling at a premium or a discount. Many other factors should affect this decision, such as the expectation of interest rates and the credit worthiness of the bond itself.

Advisor Insight

Emma Muhleman, CFA, CPAAscend Investment Partners, Grand Cayman, CA

If a bond is trading at a premium, this simply means it is selling for more than its face value. Bond investments should be evaluated in the context of expected future short and long-term interest rates, whether the interest rate is adequate given the bond’s relative default risk, expected inflation, bond duration (interest rate risk associated with the length of the bond term) and price sensitivity relative to changes in the yield curve.

The bond’s coupon relative to the risk-free rate is also important to assess the opportunity cost of investing in bonds as opposed to equities. In the end, anything with the potential to impact cash flows on the bond, as well as its risk-adjusted return profile, should be evaluated relative to potential investment alternatives.

Selling the bonds at a premium has the effect of - Brainly.com

Selling the bonds at a premium has the effect of – Brainly.com – Explanation: When a bond is traded above the par value, it is being sold at premium. Since the bond is sold above it, the interest rate is higher but the cost to borrow money is lower. Purchasing a bond a premium is expensive because it is above market value but selling a bond at premium contributes to more money made off of the sale.So, a premium bond has a coupon rate higher than the prevailing interest rate for that particular bond maturity and credit quality. A discount bond by contrast, has a coupon rate lower than the prevailing interest rate for that particular bond maturity and credit quality. An example may clarify this concept. Let's say you own an older bondThe Impact of Bonds on Financial Statements. A bond is a debt product a company sells to investors — such as investment banks, rich people and pension funds — privately or on public exchanges, also known as debt markets. Bond transactions affect various financial statements, from income statements and balance sheets to statements of cash

What's the Difference Between Premium Bonds and Discount – Bonds have a face value, typically some multiple of $1000, which is the amount you get when the bond matures. Bonds are quoted as a percentage of face value. A bond with a face value of $1000During periods when interest rates are continually falling, bonds will trade at a premium so that the YTM moves closer to the falling interest rates. Similarly, rising interest rates will result in more bonds trading at a discount of par value. Why a Bond Sells at a Discount. A bond may be issued at a discount for the following reasons: 1.Where the Premium or Discount on Bonds Payable is Presented. The premium or the discount on bonds payable that has not yet been amortized to interest expense will be reported immediately after the par value of the bonds in the liabilities section of the balance sheet. Generally, if the bonds are not maturing within one year of the balance sheet

What's the Difference Between Premium Bonds and Discount

The Impact of Bonds on Financial Statements | Bizfluent – Selling the bonds at a premium has the effect of Question options: raising the effective interest rate above the stated interest rate. increasing the amount of cash paid for interest each 6 months. causing the total cost of borrowing to be higher than the bond interest paid. causing the total cost of borrowing to be lower than the bond interestBonds can become premium or discount bonds, trading above or below their par value while bond traders attempt to make money trading these yet-to-mature bonds. A premium bond trades above its issuance price—its par value. A discount bond does the opposite—it trades below par value. Bonds Don't Have a Fixed PriceSelling The Bonds At A Premium Has The Effect Of Raising The Effective Interest Rate Above The Stated Interest Rate Attracting Investors That Are Willing To Pay A Lower Rate Of Interest Than On Similar Bonds Causing The Interest Expense To Be Higher Than The Bond Interest Paid Causing The Interest Expense To Be Lower Than The Bond Interest Paid D)…

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