A premium bond is a bond that has a market value of more than the face value of the bond. Bonds are normally traded at below par value but if the interest rate prevailing in the market is lower than the coupon offered by a bond the bond’s market value will be above par value and it will be traded at a premium on face value.
Assume a 10 years bond has a coupon rate of 8% that will pay $80 ($1,000 x 8%) every year and will mature in 10 years at par. The cash flows associated with the bond will be discounted at 7% a lower rate than the coupon rate.
The following will be the market value of the bond.
|
Year |
Cash Flows |
Discount factor 7% |
Present Value |
|
|
1 |
80 |
0.934579 |
74.76636 |
|
|
2 |
80 |
0.873439 |
69.8751 |
|
|
3 |
80 |
0.816298 |
65.30383 |
|
|
4 |
80 |
0.762895 |
61.03162 |
|
|
5 |
80 |
0.712986 |
57.03889 |
|
|
6 |
80 |
0.666342 |
53.30738 |
|
|
7 |
80 |
0.62275 |
49.81998 |
|
|
8 |
80 |
0.582009 |
46.56073 |
|
|
9 |
80 |
0.543934 |
43.5147 |
|
|
10 |
1080 |
0.508349 |
549.0172 |
|
|
Market value of Bond |
1070.236 |
|||
Miller Corporation has a premium bond making semiannual payments. The bond
Bond P is a premium bond with a 9 percent coupon.
Bond X is a premium bond making annual payments. The bond
Bond P is a premium bond with an 8 percent coupon,
Bond P is a premium bond with a 12 percent coupon.
Locate the Treasury bond in Figure 7.4 maturing in November
Bond P is a premium bond with a coupon rate
Bond P is a premium bond with a coupon of 8.
Consider again the two bonds in Question 13. If the investment
Miller Corporation has a premium bond making semiannual payments. The bond
