A premium bond is a kind of bond that is being traded on the value that is high or above the original par value of the bond. A bond is called to be traded at the premium when the coupon rate offered by the bond is higher than the prevailing interest rate of the bond. The reason behind the trading of the premium bond is that investor wants to have a high rate of return and is ready to pay more for it. The premium bond is a bond that is issued in certain nation such as United Kingdom and Canada. For example in United Kingdom the premium bonds are considered as the lottery bonds that are issued by the Government itself under its scheme called British Government’s National Savings and Investment Schemes. In Canada the Canadian Premium Bond that were first introduced by Canadian Government in year 1998. This premium bond offers a high interest rate at the time of issuance as compared to Canada Savings Bonds.
The premium bond can be explained by the example where the bond has the premium rate of 7 percent when the prevailing interest rate in the market is 5 percent. The investor dealing with these kinds of bonds will bid up the price of the bond until its yield to the maturity become in line with the market interest rate of 5 percent. As a result of bidding up the price of the bond the bond will trade at the premium that is equal to its par value.
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