You are watching: If bonds are issued at a premium the stated interest rate is
Somer G. Anderson is CPA, medical professional of accounting, and also an accounting and finance professor who has actually been working in the accountancy and finance markets for more than 20 years. Her specialization covers a wide selection of accounting, corporate finance, taxes, lending, and personal finance areas.
When the terms premium and discount are supplied in recommendation to bonds, they room telling investors that the purchase price of the shortcut is either over or listed below its par value.
For example, a bond with a par worth of $1,000 is selling at a premium once it have the right to be to buy for much more than $1,000 and is marketing at a discount when it have the right to be to buy for less than $1,000.
Bonds deserve to be offered for an ext and much less than their par values since of an altering interest rates. Like most fixed-income securities, bonds room highly associated to interest rates. When interest prices go up, a bond"s industry price will certainly fall and also vice versa.
To far better explain this, let"s look in ~ an example. Imagine the industry interest price is 3% today and also you simply purchased a bond payment a 5% coupon through a challenge value that $1,000. If interest prices go down by 1% from the time of her purchase, friend will have the ability to sell the bond because that a benefit (or a premium). This is due to the fact that the link is now paying an ext than the sector rate (because the coupon is 5%).
The spread supplied to be 2% (5% - 3%), but it's now boosted to 3% (5% - 2%). This is a simplified means of looking at a bond's price, as countless other factors are involved; however, the does display the general relationship between bonds and also interest rates.
As for the attractiveness that the investment, you can"t determine whether a shortcut is a an excellent investment solely based on whether it is selling at a premium or a discount. Plenty of other components should influence this decision, such as the expectation of attention rates and the credit worthiness that the bond itself.
Emma Muhleman, CFA, CPAAscend investment Partners, Grand Cayman, CA
If a shortcut is trading in ~ a premium, this simply method it is marketing for an ext than its face value. Bond investments need to be evaluate in the context of meant future short and also long-term interest rates, whether the interest price is adequate provided the bond"s family member default risk, supposed inflation, shortcut duration (interest rate risk associated with the size of the bond term) and also price sensitivity loved one to changes in the productivity curve.
The bond’s coupon loved one to the risk-free rate is also important to assess the opportunity cost of investing in bonds together opposed to equities. In the end, anything v the potential to influence cash flows on the bond, and its risk-adjusted return profile, have to be evaluated family member to potential investment alternatives.
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