Understanding a Premium Bond

The term premium bond is commonly used in the bond market today. Here are the basics of a premium bond and why it is important to investors.

Premium Bond

When investing in bonds, it is important to understand that the value of the bond is inversely related to market interest rates. This means that as the interest rate increases, the value of your bond is going to decrease. When interest rates in the market go down, the value of your bond is going to increase. A premium bond is one that is worth more than the face value of the bond because interest rates in the market are below the interest rate that is currently being paid by the bond.

Example

For example, let's say that you purchased a $1000 bond that paid a coupon rate of 4 percent. Then, interest rates in the market went down to 2 percent. At that point, someone might be willing to pay you $1100 for your bond instead of the face value of $1000. They know that they will have to pay more than the face value of the bond because of the higher interest rate that is attached to the bond. 

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