After an extended break, I am back to tell you what it means to buy a bond at a premium. Hope you weren’t here waiting that entire time….

Bonds have a par value/price–one bond is usually $1,000. On top of that, you have a coupon rate (which is the interest rate you earn on the bond and is referred to as yield also).

So let’s say you buy 5 GE bonds for $5,000 with a coupon of 10% (yeah, not unless it’s a junk bond….but it makes my math easier) and a maturity of 1.10.2010 (meaning you will get interest until then, and then you’ll get your $5k back).

You will get 10% interest on 5, $1,000 bonds.

Oh, but now your car broke down and you need some money to fix it. Interest rates have dropped, so your 10% coupon rate is very attractive to buyers of bonds. If you sell your 5 bonds, you can sell them for MORE than $1,000 each–and that is selling at a premium (your buyer is buying them at a premium).

Now….

Since your buyer is buying the bonds, let’s say for $1,100 each, while his or her coupon rate will remain the same, he will yield less because he paid more for the bonds. You had only paid $5,000 and got an income of $500 per year, yielding 10%.

Your buyer will be paying $5,500 and getting that same $500 income from the coupon rate, which reduces his yield to only 9% (broken up into a monthly yield this number would be much smaller).

Later,

Yo