Premium bond
A bond whose market price sits above its par value because the prevailing market interest rate is lower than its coupon — the mirror image of a discount bond.
In plain language
A discount bond trades below par when market rates rise above its coupon. A premium bond is the mirror image. It trades above par because the prevailing market interest rate has fallen below its coupon.
The workbook's rule: if the market interest rate is below the bond's coupon, the bond will sell at a premium to the par value. A bond promising a higher-than-market coupon is worth more than its face value to a new buyer, so its price rises until the return on offer matches what the market now demands.
How it works
The YTM link (Chapter 4, section 4.4.2). When a bond sells at a premium, its yield to maturity is lower than its coupon rate. The buyer pays extra today for the above-market coupon, and gives some of that back as a built-in capital loss to face value at maturity; the YTM nets the two together.
| Compare | At par | At a premium |
|---|---|---|
| Market price vs face value | Equal | Above |
| YTM vs coupon rate | Equal | YTM below coupon |
The workbook states the direction of the relationship but gives no formula or percentage specific to premium bonds as a category. The size of the premium follows from the discounted cash flow approach used for intrinsic value of a bond, not from a separate rule.
A worked example
A company issued a 5-year, ₹1,000 face value bond at a 9% coupon three years ago. Interest rates have since fallen, and comparable 2-year corporate paper now yields 7%.
An investor would happily pay more than ₹1,000 today for a bond that keeps paying a 9% coupon when the market offers only 7%. The price rises until the YTM, at that higher price, works out close to 7% — say the price settles near ₹1,038, a premium of ₹38 to par.
That buyer collects ₹90 a year in coupons but gives back the ₹38 premium as a capital loss over the remaining two years, when the bond redeems at ₹1,000. Netted together, the two years' return comes close to the market's 7%, lower than the 9% coupon alone would suggest — exactly why YTM, at about 7%, sits below the coupon of 9% on a premium bond.
Why NISM asks about it
Chapter 4 (Investing in Fixed Income Securities), section 4.2, states the premium rule alongside the discount rule, and section 4.4.2's YTM-versus-coupon relationship covers both directions together. Expect a question giving a coupon and a lower market rate and asking for the resulting price direction, or the YTM comparison.
Common exam traps
- Premium means market rate below coupon; the bond costs more than its face value. Do not reverse this with the discount case.
- A premium bond's YTM is below its coupon rate — the extra price paid upfront offsets part of the higher coupon.
- A high coupon does not by itself mean a good deal — it is exactly what makes the bond expensive when market rates fall.
- This is a market-price phenomenon on an ordinary bond, not a distinct product, the same caution that applies to discount bond.
Where this is taught
Free preparation for NISM Series XXI-ARelated terms
- Face valueThe denomination a company's capital is divided into and carried in its books — fixed, printed on the certificate, and the base on which dividend percentages and stock splits are computed.
- Yield to MaturityThe single discount rate at which a bond's future coupons and redemption amount add up to exactly its market price today — the return you actually earn if you hold it to maturity.
- Discount bondA bond whose market price sits below its par value because the prevailing market interest rate is higher than its coupon — a market-price condition of an ordinary bond, not a distinct bond type.
- Intrinsic value of a bondThe sum of the present values of all a bond's future cash flows, discounted at the investor's required rate of return. Buy if it exceeds the market price; sell if it is below.