Short answer
Yield above coupon: discount. Yield below coupon: premium. Equal: par. A 5% 10-year semi-annual bond is $1,171.69 at 3%, $1,081.76 at 4%, $1,000 at 5%, $925.61 at 6% and $857.88 at 7%.
1. The rule
| Market yield vs coupon rate | Price vs face value | Called |
|---|---|---|
| Yield above coupon | Below | Discount bond |
| Yield equals coupon | Equal | Par bond |
| Yield below coupon | Above | Premium bond |
2. Prices for a 5% bond
$1,000 face value, 5% coupon, 10 years, semi-annual payments:
| Market yield | Price | Current yield |
|---|---|---|
| 3% | $1,171.69 | 4.27% |
| 4% | $1,081.76 | 4.62% |
| 5% | $1,000.00 | 5.00% |
| 6% | $925.61 | 5.40% |
| 7% | $857.88 | 5.83% |
Current yield is the annual coupon ($50) divided by the price.
4. Which is better?
Neither is better in itself. A discount bond has lower cash coupons but a built-in gain toward par, and a premium bond has higher coupons offset by a loss toward par. The yield to maturity captures both effects.
5. Frequently asked questions
Why does a bond trade at a discount?expand_more
Because its coupon is lower than what new bonds pay, so buyers pay less than face value to earn the market yield.
Is a premium bond a bad buy?expand_more
Not necessarily. Higher coupons are offset by the premium shrinking to zero at maturity; compare bonds on yield to maturity.
What is current yield?expand_more
The annual coupon divided by the current price. It ignores the gain or loss as the price moves to par.
Does a premium or discount stay forever?expand_more
No. The price moves toward face value as maturity approaches.