Mastering Premium vs Discount Bonds: A Beginner’s Guide

As interest rates fall, bond prices rise while conversely, rising interest rates lead to falling bond prices. When bond prices change, the amount of interest payments remains the same, but its yield – the actual return an investor will get on his money discount vs premium bond – will change. When it comes to buying premium vs. discount bonds, there is no wrong answer. Consider the strategy behind buying at a discount or buying at a premium, and seek to capitalize on either the annual yield or the face value of the bond.

Adam received his master’s in economics from The New School for Social Research and his Ph.D. from the University of Wisconsin-Madison in sociology. He is a CFA charterholder as https://personal-accounting.org/mark-to-market-mtm-what-it-means-in-accounting/ well as holding FINRA Series 7, 55 & 63 licenses. He currently researches and teaches economic sociology and the social studies of finance at the Hebrew University in Jerusalem.

Effective Yield on Premium Bonds

This is usually because the company is losing money or is in a bad financial position. Bonds trade on a secondary market, so the price of the bond floats either below or above the original par value based on supply and demand. Conversely, as interest rates rise, new bonds coming on the market are issued at the new, higher rates pushing those bond yields up. A bond selling at a premium is one that costs more than its face value, while a discount bond is one selling below face value.

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. 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. An author, teacher & investing expert with nearly two decades experience as an investment portfolio manager and chief financial officer for a real estate holding company.

What is the Difference Between Premium and Discount Bonds?

A bond issued at a discount has its market price below the face value, creating a capital appreciation upon maturity since the higher face value is paid when the bond matures. The bond discount is the difference by which a bond’s market price is lower than its face value. A premium bond is one for which the market price of the bond is higher than the face value. If the bond’s stated interest rate is greater than those expected by the current bond market, this bond will be an attractive option for investors.

On the other hand, a bond discount would enhance, rather than reduce, its yield to maturity. However, the „discount“ in a discount bond doesn’t necessarily mean that investors get a better yield than the market is offering. Instead, investors are getting a lower price to offset the bond’s lower yield relative to interest rates in the current market. For example, if a corporate bond is trading at $980, it is considered a discount bond since its value is below the $1,000 par value.

What is the difference between discount bond and Premium Bond?

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%). Bonds can be sold for more and less than their par values because of changing interest rates.