DEFINITION of Agio
Agio is a description of a bond premium – for example, when a bond’s market value is greater than its par value. In international markets, agio can also sometimes refer to the fee for undertaking a transaction. Because these bonds are often traded on international markets, the agio premium is also used to describe the premium to exchange currencies.
BREAKING DOWN Agio
Agio is a less common term for spread; it is not commonly used in Canada or the U.S. Historically, it denoted the differences between two currencies in the same country; today, it can refer to this difference among countries. For example, certain currencies are valued more highly in some scenarios than others, such as airports. Because airports are seen as the last port of call, the rates at airport exchanges will generally be more expensive than those at a retail bank in the city of departure.
In contrast, rates that a currency exchange quotes are typically close to the spot rate, though the exchange generally tacks on a small amount for the transaction in order to make a profit.
While the largest trading centers for foreign exchange are London, New York, Singapore and Tokyo, there is no centralized market for forex transactions (which are generally far larger than airport exchanges). Forex (also called FX) transactions are executed over the counter and around the clock.
Agio and Bond Values
To understand agio, it’s helpful to place it in the context of bond valuation. Bond valuation is complex and multifaceted, due in part to the inherent complexity of bonds, along with there being several different types of bonds, such as corporate, municipal, and U.S. government bonds. (Bonds even exist among non-profits and certain ministries.) At its core, a bond is a debt obligation between an issuer and a borrower. It is an investment by a creditor that delivers fixed income. The investor loans money to an entity (e.g. a company or government), which in turn borrows the funds for a defined period of time at a variable or fixed interest rate.
To determine what a bond is worth, consider both an intrinsic and market valuation. For example, to figure out a bond’s inherent worth, calculate the present value of its expected (future) cash flows. (This first involves estimating the expected cash flows and then determining the appropriate interest rate to discount them.) Following this, add up the cash flows. At times, the figure you arrive at is different than the market value (current market price). The difference between these two can be considered the agio.