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Premium has a few different meanings in the financial world.

In one context, premium is the total value of an option, representing the sum of its intrinsic and time values. Suppose an investor buys a call option for $6 on ABC Corporation. The strike price is $105, and ABC is trading at $110. The option’s intrinsic value is $5. The option’s time value is the $1 above its intrinsic value. The more time left until expiration, the more time the option has to move in a favorable direction.

In another context, the premium is the price above a fixed-income’s face value that an investor pays to buy it. A bond with a $1,000 face value that’s selling for $1,100 is selling at a premium of $100. Bonds sell at a premium when existing interest rates are lower than the coupon rate. Since the bond is returning a higher rate than the current interest rate, investors will pay extra to buy it.

And in a third context, a premium is the payment the holder of an insurance policy makes to be covered by the policy. For example, a car owner pays a fixed premium, often monthly or quarterly, to an insurance company to obtain auto insurance. In return, the car owner receives protection in the event of an accident, theft, or other problem.

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