Agio

What is Agio?

Agio can refer to a bond premium (when the market value of the bond is greater than its par value) or a fee paid for a foreign exchange transaction.

Understanding Agio

Because bonds are often traded on international markets, the agio premium is used to describe the premium to exchange currencies. Essentially, agio is a less common term for spread, though it is not commonly used in Canada or the United States. Historically, agio denoted the differences between two currencies in the same country. Nowadays, it can refer to the spread between the currencies of two different countries.

For example, certain currencies are valued more than other currencies in some venues, such as airports. Because airports are seen as the last port of call, the exchange rates at airports will generally be more expensive than those at a retail bank in the departure city. 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 include London, New York, Singapore and Tokyo, there is no centralized market for forex transactions (which are generally far larger than airport exchanges). Forex 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.