What does it mean when a bond is selling at a premium? Is it a good investment?

Bonds / Fixed Income
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September 2016
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Hello,

Glad you ask the question before you jump into the bond wagon. Here’s a simple example of learning bond. If a bond sells at its par value or face value, $1,000, with a 5-year term and 5% interest, you will get your $1,000 principal back, plus the annul $50 interest at its maturity. However, life is not always that simple and straight forward as we hope it to be. Depending on the supply and demand, bond’s price can vary, thus the premium or discount price. 

For example, when the interest rate falls, older bonds may become valuable because they were sold in a higher interest rate environment and therefore with a higher coupon rate. Consequently, investors holding those bonds can commend a "premium" to sell them. On the other hand, if interest rate rises, older bonds may become less valuable. In order to get rid of them, investors may have to sell for less, thus the "discount” price.

Bond prices are quoted as a percent of the bond’s face value, and an easy way to learn the price of a bond is simply adding a zero to the price quoted. For instance, when you hear a bond is quoted at 99, it means the price for the bond is $990 for every $1,000 of face value. Because the bond price is below the face value, it’s said the bond is traded at a discount. On the other hand, if the bond is trading at 101, it means you will pay $1,010 to get that $1,000 face value bond. Thus, you’re paying a premium. Happy learning!

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