What Is Unamortized Bond Premium?
Let me explain unamortized bond premium directly: it's the difference between a bond's face value and its sale price when sold above par. If a bond sells for more than its face value, say at $1,090 for a $1,000 bond, that $90 premium is what we're talking about. The issuer still repays the full face value at maturity, but until then, this unamortized amount sits as a liability because it hasn't been paid out or written off yet.
Key Takeaways
You need to grasp that unamortized bond premium is the net difference between the price at which a bond issuer sells the securities and the bonds' actual face value at maturity. It's a liability for issuers since they haven't written off this interest expense, though it will come due eventually. On financial statements, you'll see it recorded in a liability account specifically called the Unamortized Bond Premium Account.
Understanding Unamortized Bond Premium
The bond premium itself is the amount over the face value that the bond is priced at. When interest rates in the economy drop, bond prices rise because the market rate falls below the fixed coupon rate on existing bonds. Bondholders with these higher-interest bonds demand a premium to sell them in the market.
What remains after some amortization is the unamortized bond premium—the part the issuer hasn't yet written off as interest expense. For instance, suppose a bond issuer sells bonds with a 5% fixed coupon when rates are 5%. Later, rates drop to 4%, so new bonds have lower rates. Investors wanting the higher coupon pay a premium, like $1,090 for a $1,000 face value bond, leaving $90 as the unamortized premium.
This unamortized portion will be amortized against future expenses, credited as interest expense. If the bond pays taxable interest, you as the bondholder can choose to amortize the premium to cut down on taxable interest income.
Special Considerations
If you're investing in taxable premium bonds, amortizing the premium benefits you by offsetting the bond's interest income, which lowers your taxable income from the bond. Each year, the bond's cost basis drops by the amortized amount.
For bonds with tax-exempt interest, you must amortize the premium, though it's not deductible for taxable income. Instead, reduce your basis in the bond by that year's amortization.
From the issuer's side, unamortized bond premium is a liability on the balance sheet, tracked in the Unamortized Bond Premium Account, representing what's left to amortize over the bond's life.
Example: Unamortized Bond Premium Calculation
To calculate the amortizable amount for a tax year, multiply the bond price by the yield to maturity (YTM), then subtract that from the coupon rate amount. Take our earlier example with a 4% YTM: $1,090 x 4% = $43.60. Subtract from the $50 coupon (5% of $1,000), getting $50 - $43.60 = $6.40 as the amortizable amount.
For taxes, reduce your $50 interest income to $43.60. After one year, the unamortized premium is $90 - $6.40 = $83.60. In year two, the cost basis is $1,090 - $6.40 = $1,083.60, and amortization is $50 - ($1,083.60 x 4%) = $50 - $43.34 = $6.64. Remaining premium: $83.60 - $6.64 = $76.96.
If the bond matures in five years, continue this for the remaining years. For year three, cost basis would be $1,083.60 - $6.64 = $1,076.96, and so on.
Other articles for you
Market orientation is a business strategy that prioritizes understanding and meeting consumer needs to guide product development and enhance satisfaction.
Long-term debt refers to financial obligations maturing in more than one year, crucial for companies' capital raising and investors' portfolios.
The 'Old Lady' is a historic nickname for the Bank of England originating from a 1797 satirical cartoon about suspending gold payments.
A bank run happens when many customers withdraw deposits simultaneously due to fears of a bank's insolvency, potentially leading to its collapse.
Off-balance sheet items are assets or liabilities not recorded on a company's main balance sheet but still impact its financial health, requiring disclosure in notes for transparency.
A sampling distribution describes the probability of various outcomes from random samples of a population, aiding informed decisions in research and planning.
Municipal bonds are debt instruments issued by local governments to fund public projects, offering tax advantages and lower risk compared to corporate bonds.
Hazard insurance is a component of homeowners insurance that protects against damage from natural events like fires and storms.
OCBOA is a non-GAAP accounting method used for financial statements, including tax-basis and cash-basis, offering simplicity and lower costs compared to GAAP.
An endogenous variable is a dependent variable in a statistical model that changes based on other variables within the same system.