Question

Can you explain simply what a bond premium and a bond discount is. Why is interest higher for a discount bond and why would people want to get premium bonds.

Answer 1

• Bond Premium: When Bonds are issued at a price more than the amount of the face value of bond, the bonds are said to be issued on Premium. The excess of Issue price over Face Value of Bond is called Bond Premium.

Example

A	Face Value of Bonds Payable	$    1,000,000.00
B	Issued at	$    1,200,000.00
C = B - A	Premium on Bonds Payable	$        200,000.00

• Bond Discount: When Bonds are issued at a price lower than the amount of face value of Bond, the bonds are said to be issued at a discount. The excess of Face Value over Issue price of Bond is called Bond Discount.

Example

A	Face Value of Bonds Payable	$    1,000,000.00
B	Issued at	$        800,000.00
C = A - B	Discount on Bonds Payable	$        200,000.00

• Interest expense is higher for Discount Bond because Interest is recorded at a Market rate that is higher than coupon rate if the Bonds are issued at Discount.

This is why Interest is higher for corporation issuing the Bonds Payable, issued on discount.

• People would want to get Premium Bonds because the bonds issued at Premium PAY interest income to investee at the COUPON RATE that is HIGHER than the current market Interest rate. Since coupon rate is higher than market interest rate, the bonds become more attractive to ibvest in, and people want to get premium bonds.