Amortizable Bond Premium

  

Big term, simple concept. When a bond has a higher coupon than current interest rates, you pay a premium for it (i.e., more money). That premium can be amortized for tax purposes, meaning that it is split up over a period of years.

Put simply, you then take a portion of that premium each year against your cost basis (what you actually paid for it). Like...you paid $1,050 for a $1,000 par value bond with a coupon of 6% coming due in 5 years. You'd get 60 bucks a year for those 5 years...but you'd amortize away for tax purposes the 10 bucks you lost each year for 5 years as the premium value of the bond declined on its way to par.

That is, you'd pay taxes on 50 bucks (ordinary income), not on the $60 in cash you made as the amortization of the decline in value from premium to par functions essentially as a tax buffer.

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Finance: What is Par Value?113 Views

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Finance a la shmoop what is par value okay mercifully we'll dispense [Man taking a swing with a golf club]

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with the golf jokes but with one exception par in golf and it relates

00:15

here is the right number i.e the one you're shooting for the one you're

00:19

supposed to hit that is a par for golf hole is designed so that you hit your [A golf ball landing on the fairway]

00:24

drive then you hit your approach shot which is meant to land on the green and

00:27

then your quote supposed to unquote to putt for a total of four strokes at par [Man struggling to put the ball in the golfer hall]

00:32

4 right and it may or may not include saying close enough and picking up your

00:36

ball five feet away from the hole while calling it a gimme so yeah that's par

00:40

four strokes on a par 4 well in finance par value generally relates to the [Definition of par value relating to pricing of bonds written on chalkboard]

00:45

pricing of bonds and you'll see where we're going here with the right number

00:49

in quotes for a bond a corporation needs to borrow money to say build a new nose [Elephant using a noseclipper and chasing a man]

00:54

clipper factory well that new factory will allow the corporations

00:59

export Clippers to China and allow its products to be more high-tech yeah these

01:03

things are now the equivalent of a Brazilian wax for your nostrils anyway [Man giving a Brazilian wax to another mans nostrils]

01:07

the company along with its bankers believes that it should have to pay

01:10

about six percent interest on the loans it's taking out so it markets its bonds

01:14

as six percenters and in the process a more positive story is told to Wall [Men discussing the nose clipper industry bonds on Wall Street]

01:18

Street about the future of nose clipping technology as pioneered by shnozholes

01:24

Inc the perceived risk in the bond so sound and there's a lot of demand by [People looking up at Shnozholes, Inc building]

01:28

them the standard unit in which a bond is generally sold is a thousand dollars

01:33

that's a thousand dollars for each unit of a bond got it so on one unit of a

01:38

typical bond that thousand dollars interest is paid twice a year ie in this

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case the company would be paying thirty bucks twice a year to rent each unit of [Company paying a bank $30 twice]

01:48

it's thousand dollar loan so the company issues the bonds and all of a sudden

01:52

they trade up on strong demand from Wall Street to eleven hundred dollars per

01:56

unit well a new buyer of the bond would be getting less than six percent [A new person buying bonds from the company]

02:01

interest when they bought that bond for 1,100 bucks because even though they

02:04

still get 30 bucks twice a year in bond rent money instead of paying a grand for

02:09

that 60 bucks a year they had to pay 1100 dollars for it in fact at 11 hundred [Buyers trading $1000 for $1,000]

02:13

dollars and still getting 60 bucks a year the interest rate has fallen to

02:18

about 5.45 percent ie less than six the quote right unquote value of that bond

02:24

or its par values yeah we went there, was a thousand bucks that's where it was

02:29

priced when it was offered and it's that thousand dollars from which the interest [Bank with a thumbs up beside the par value price]

02:33

payments are pegged how do we know what par value is well you can guess.. little

02:39

birdie told us [golfball striking a little bird perched on a tree]

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