Question

Explain the difference between discount bonds and premium bonds. When do bonds trade at face value? How do discount bonds behave? How do premium bonds behave? What is the nature of the returns from discount bonds vs. those from premium bonds?

Answer 1

discount bonds are those which trade at a price lower than the face value and premium bonds are the ones which trade at a price higher than the face value. A bond trades at face value when its coupon rate is equivalent to the market interest rate all the yield to maturity.

Discount bonds are discounted because their coupon rate is lesser than the yield to maturity. Similarly premium bonds sell at a premium because they offer coupon rate higher than the market interest rate. Hence returns from the premium bonds are higher than the returns from the discount bonds.