Now that bond calculators have been covered…let’s learn about bond premiums and bond discounts.
What is a bond premium?
A bond selling at premium is a bond that is trading above its par value. A bond is considered to be trading at premium when it offers a coupon rate higher than its prevailing interest rates. This is because investors want a higher yield and will pay more for it.
Oppositely, a bond is selling at a discount when it can be bought for less than its par value.
What is a bond discount?
A bond discount is the amount by which the market price of a bond is lower than its par value (typically $1,000) due at maturity. Bond prices are quoted as a percentage of face value, so a price of 95.00 means that the bond is selling for 95% of its face value of $1,000.00 and the bond discount is 5%.
A bond discount will enhance the yield to maturity of the bond. A bond premium will reduce its yield. The size of the premium will decline as the bond approaches maturity.
Keep in mind that you can't determine whether or not a bond is a good investment solely based on whether it’s selling at a premium or a discount. Many other factors must be taken into account. To learn more about bonds, check out the free course on Investing in Different Markets!