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A premium bond is one that trades above its face or nominal amount. This happens when the bond’s coupon rate is above the prevailing interest rate.  Investors will pay more for the bond in order to get the higher coupon rate. By trading the bond at a premium, investors affect the yield of the bond since the interest rate stays the same. A bond that trades at a premium has an effectively lower yield than its stated coupon rate. Conversely, a bond that trades at a discount has a higher yield than its stated coupon rate.

For instance, a if a 5-year bond has a stated coupon rate of 6%, but the prevailing interest rate is 5%, then the bond will trade at a premium. If the face amount of the bond is $1,000, investors will be willing to purchase the bond for $1043.50. If the investor holds the bond to maturity he will receive the 6% in interest, but because of the extra he paid over the face amount his return will, in effect, be 5% rather than 6%.

Premium bond has another meaning in Canada and the United Kingdom. In the U.K., Premium Bonds are issued by the National Savings & Investment Agency. These bonds offer tax-free interest that is put into a pool and paid to bondholders based on a lottery system. 

In Canada, premium bond refers to a bond issued by the Bank of Canada that pays a higher interest rate than Canada Savings Bonds.

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