Bond Pricing: Par, Premium Or Discount
June 24, 2009 by Tisa Silver
Filed under Finance
Similar to the many prices contained in one stock quote, bond quotes may contain many interest rates. The rates are all important because their relationship reveals how bonds are priced.
Here are some rates to be mindful of if you are in the market for bonds.
Photo by kugelfish, courtesy of flickr
Coupon rate – The coupon rate is the rate which determines the size of the bond’s periodic interest payments.
Interest can be paid annually or semi-annually. If the coupon rate is 5 percent, then the bondholder will collect 5 percent of the bond’s par value every year.
Current yield – The current yield is the coupon payment divided by the current price of the bond. The price of a bond can fluctuate, and as it changes so will the current yield.
Yield to maturity (YTM)- The yield to maturity is the overall rate of return on the bond assuming that the bond is held until it matures. The yield to maturity also assumes that all coupon payments are received and reinvested at the same rate.
Think of the yield to maturity as the going rate of return for bonds of similar risk and length to maturity. The coupon rate is determined by the bond’s issuer, and it does not have to equal the yield to maturity. How the two rates stack up will determine if the bond sells at a discount, premium or at par.
If the rates are the same, then the bond will sell at par. If the coupon rate is greater than the yield to maturity, then the bond will sell at a premium to par value. If the coupon rate is less than the yield to maturity, then the bond will sell at a discount to par value.
If you plan on investing in bonds, get familiar with interest rates. Bond prices depend on them and so can credit card, auto loan and mortgage rates. For more information on interest rate changes, here’s a link to one of my articles, “How Interest Rate Cuts Affect Consumers,” on Investopedia.
