Question

How to choose between a premium bond and a discount bond with the same YTM ＝market rate

Answer 1

if a bond that's mercantilism on the market is presently valued above its original price (its par value), it's known as a Premium bond. Conversely, if a bond that's trading on the market is presently valued lower its original price (its par value), it's known as a discount bond.

So, a premium bond encompasses a coupon rate above the prevailing rate of interest for that individual bond maturity and credit quality. a reduction bond against this, encompasses a coupon rate under the prevailing rate of interest for that individual bond maturity and credit quality.

An example could clarify this idea. Let’s say you own associate degree older bond, one that was originally a 10-year bond once you bought it 5 years past. This bond encompasses a five-hitter coupon rate and you would like to sell it currently. once you sell it, your bond are going to be competitive on the market with new bonds with a 5‑year maturity, since 5 years is that the time left till your bond matures. Let’s assume that those new bonds, love yours in credit quality, have a coupon rate of three. Investors can “bid up” the value of your bond till its yield to maturity is in line with the competitive market rate of interest of three. attributable to this bidding-up method, your bond can trade at a premium to its face value. Your vendee pays additional to buy the bond, which premium the client pays can scale back the yield to maturity of the bond, thus it's in line with what's presently being offered. (By distinction, a bond discount would enhance, instead of scale back, its yield to maturity.)

So, the nice equalizer could be a bond’s yield to maturity (YTM). The YTM calculation takes into consideration the bond’s current value, its face value, its coupon rate of interest, and its time to maturity. It conjointly assumes that every one coupon payments area unit reinvested at identical rate because the bond’s current yield. YTM is associate degree correct calculation of a bond’s come back that permits investors to check bonds with completely different costs, maturities, and coupons. we have a tendency to continuously need to buy bonds with the very best YTM, given equivalencies in maturity, credit good, and trade.