Question

When will a bond trade at a premium? Explain.

Which bonds will be the most sensitive to changes in yields? Explain.

Answer 1

Bond premium = When bond is traded in the secondary market more than its face value.  

There are several reasons why bonds are trading at premium one of the reason is coupon rate of bond is higher than the market interest rate.

If coupon rate is higher then the market interest rate that means bonds is earning more then the general market expectation. More and more people wants to buy the bond and the price of the bonds will increases. Since it is higher return investment.

There are two types of bonds

1. Bonds with longer maturity.

2. Bonds with shorter maturity.

Generally bonds with longer maturity are more sensitive to change in yields. There is inverse relation between bond price and yield, In the long run changes in the market yield will effect the overall return of the bond. However in shorter period bonds are less risky because generally yield in not change in the short period hence risk is less substantial in the short duration as compare to longer duration.