What Are Discount Bonds and Premium Bonds
The bond market is full of terminology. Fortunately, this one is pretty easy. When a bond is first issued, its price is usually set a $1,000 per bond which is quoted as 100.00. The interest rate for the bond is fixed at issue as well.
However, market interest rates will continue to fluctuate even though the bond's interest rate remains fixed. This causes the value of the bond to change. As you can imagine, a bond that pays more than current interest rates would be more valuable to investors than a bond that pays less than current interest rates, all other things being equal.
An easy way to remember this feature of bonds is to think of a teeter-totter, or see-saw, with interest rates on one side, and bond prices on the other. When, interest rates go down, bond prices go up. When interest rates go up, bond prices go down.
Indeed, a bond paying 8.0% when the prevailing rates for the same term are 6.0% can be expected to trade significantly above the original $1,000 per bond price. This would be reflected in a quote price above 100.00. For example. a bond trading for $1,500 per bond would be quoted at 150.00.
Any bond trading above $1,000 per bond, or 100.00, is called a premium bond. Conversely, any bond trading beneath $1,000 per bond, or under 100.00, is called a discount bond.
