As we tend to all grasp that the bond is a loan from an investor to a borrower. On the opposite hand, Premium is something that is over and higher than the particular price.

Premium Bond refers to the money instrument that is listed at a price higher than its face value.

Premium on the bond occurs when the coupon rate of the bond exceeds its prevailing market rate of interest. For example, a bond with a face value of Rs. 1000 trading at Rs.1050 reflect that the bond is trading at a premium i.e.(Rs.1050-Rs.1000= Rs. 50)

Bond trading at a premium or discount occurs in the secondary market.

Bond at a premium is determined when the new bonds with similar attributes provide a lower interest rate and hence the investors stay attracted to the existing bonds due to a higher rate of interest and this concludes the existing bond to be trading at a premium.

How does Premium Bonds work:

Bonds are considered to be a safer asset class for investment as compared to stocks for many reasons.

They generate fixed income to the investors irrespective of the market ups and downs.

For example, an Rs. 2000 bondholders with 5 years of maturity and having a 10% annual rate of interest will earn Rs. 200 coupons annually considering the bond is held till its maturity date.

On the contrary, there exist floating rate bonds that entitle investors to enjoy the market-changing coupon rates.

In this scenario, when new bonds offer lower coupon rates, the older bonds of the same category providing higher interest rates attract the investors.

This means the older bonds trade at a premium in the secondary market. As mentioned earlier, a bond with a face value of Rs.2000 and a 10% coupon rate is trading in the market at Rs.2200. The bondholder will still be entitled to receive Rs.200 as interest specified in the bond contract and at the maturity date, the bondholder is repaid Rs. 2000.

Generally, investors pay a higher price for a premium bond than their cheaper alternatives in hope that they would clinch further higher. However, Premium bonds are known as the best investment for risk-averse investors and equally looking for better returns in comparison to similar bonds in the market.

Capital market changes, rise or decline in the prevailing market rates, issuer’s creditworthiness highly influence the bonds wherein it determines if the bond is a discount of at premium

Bonds pricing gets significantly affected if the interest rate falls in the long run. Longer maturity bonds are more sensitive to market fluctuations.