What does a bond premium represent?

A bond premium represents the excess amount paid over the principal amount of the bond. When an investor purchases a bond for more than its face value, the difference between the purchase price and the principal amount is referred to as a bond premium. This typically occurs when the bond's coupon rate (the interest rate it pays to bondholders) is higher than current market interest rates, making the bond more attractive and thus commanding a higher price.

Understanding this concept is essential, as it influences how bonds are valued and impacts the yield an investor can expect to receive. The premium is amortized over the life of the bond, affecting the taxable income recognized by the bondholder and ultimately the return on investment when the bond matures.