premium bond

(noun)

a debt instrument bought at a price above par value

Related Terms

Examples of premium bond in the following topics:

  • The "Bond Yield Plus Risk Premium" Approach

    • The bond yield plus risk premium (BYPRP) approach is another method we can use to determine the value of an asset, specifically, a company's publicly traded equity.
    • In the BYPRP approach, we use a bond's yield to maturity, which is the discount rate at which the sum of all future cash flows from the bond (coupon payments and principal payments) are equal to the price of the bond.
    • Treasury Bond yield)
    • Estimating the value of an equity using the bond yield plus risk premium approach has its drawbacks.
    • Describe the process for the bond yield plus risk premium approach

  • Default Risk and Bond Price

    • Economists call the difference between the interest rate on the U.S. government bonds and corporate bonds the default risk premium.Investors add default risk premium to a risk-free investment, so they can invest in "risky" bonds because they earn a greater return.
    • Risk premium is always positive.
    • Taking the difference between the government bond and corporate bond interest rates, we can calculate the risk premium.
    • As the default risk increases, then the risk premium increases too.
    • Impact of a risk premium on the bond markets

  • The Term Structure

    • Unfortunately, most bonds carry coupons, so the term structure must be determined using the prices of these securities.
    • The liquidity premiumtheory asserts that long-term interest rates not only reflect investors' assumptions about future interest rates but also include a premium for holding long-term bonds (investors prefer short-term bonds to long-term bonds).
    • This is called the term premium or the liquidity premium.
    • Because of the term premium, long-term bond yields tend to be higher than short-term yields, and the yield curve slopes upward.
    • Long-term yields are also higher not just because of the liquidity premium, but also because of the risk premium added by the risk of default from holding a security over the long-term.

  • Par Value

    • Par value is the amount of money a holder will get back once a bond matures; a bond can be sold at par, at premium, or discount.
    • A newly issued bond usually sells at the par value.
    • Corporate bonds normally have a par value of $1,000, but this amount can be much greater for government bonds.
    • When a bond trades at a price above the face value, it is said to be selling at a premium.
    • Assess when a bond should be sold at its par value

  • Calculating Yield to Maturity Using the Bond Price

    • To achieve a return equal to YTM (i.e., where it is the required return on the bond), the bond owner must buy the bond at price P0, hold the bond until maturity, and redeem the bond at par.
    • If the yield to maturity for a bond is less than the bond's coupon rate, then the (clean) market value of the bond is greater than the par value (and vice versa).
    • If a bond's coupon rate is less than its YTM, then the bond is selling at a discount.
    • If a bond's coupon rate is more than its YTM, then the bond is selling at a premium.
    • If a bond's coupon rate is equal to its YTM, then the bond is selling at par.

  • Yield to Maturity

    • If the yield to maturity for a bond is less than the bond's coupon rate, then the (clean) market value of the bond is greater than the par value (and vice versa).
    • If a bond's coupon rate is less than its YTM, then the bond is selling at a discount.
    • If a bond's coupon rate is more than its YTM, then the bond is selling at a premium.
    • If a bond's coupon rate is equal to its YTM, then the bond is selling at par.
    • You pay $90 for the bond.

  • Call Provisions

    • A callable bond (also called redeemable bond) is a type of bond that allows the issuer of the bond to retain the privilege of redeeming the bond at some point before the bond reaches its date of maturity.
    • Most callable bonds allow the issuer to repay the bond at par.
    • With some bonds, the issuer has to pay a premium, known as the call premium.
    • The price behavior of a callable bond is the opposite of that of puttable bond.
    • Price of callable bond = Price of straight bond – Price of call option

  • The Cost of Common Equity

    • The CAPM shows that the cost of equity is equal to the risk free rate plus a premium expected for risk.
    • This premium is sensitized to movements in relevant markets using the beta coefficient.
    • Another approach to calculating the cost of common stock is to add a risk premium to the cost of debt.
    • The risk premium is the additional rate that must be paid to common shareholders above what is paid to bond holders, given the amount of risk carried by the equity.
    • Expected return for a security equals the risk-free return for the market plus the beta for the security times its risk premium.

  • Liquidity and Bond Prices

    • We start the analysis with the same liquidity in both the government bond and corporate bond markets in Figure 2.
    • Thus, both bond markets have the identical equilibrium bond price, P*, and hence, the exact liquidity.
    • Thus, the government bond prices rise, which reduces the interest rate for government bonds.
    • On the other hand, the corporate bond prices decrease, raising the market interest rate for corporate bond.
    • Nevertheless, economists refer the difference in interest rates as a risk premium.

  • Deciding to Refund Bonds

    • Bond refunding occurs when all three of the following are true
    • Interest rates in the market are sufficiently less than the coupon rate on the old bond
    • The sinking fund has accumulated enough money to retire the bond issue.
    • This involves computing the after-tax call premium, the issuance cost of the new issue, the issuance cost of the old issue, and the overlapping interest.
    • The call premium is a cash outflow.