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 Bond Amortization?7 Views

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Finance a la shmoop what is bond amortization? okay fancy term easy

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concept the basic idea is that you have to "revalue" what a bond is

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actually worth each period which usually means twice a year because bonds pay [Monthly calendar appears]

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interest on the you know semester system yeah twice a year so let's say you've

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paid seven hundred bucks for a bond with a 5% coupon which comes due for a

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thousand bucks in ten years over that time you'll have received two things the

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5% per year interest from the bond in cash paid along the way and the [5% interest per year appears]

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appreciation of the 700 bucks to become the thousand dollar par value at which

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point it will eventually pay back its principal so to amortize the $300 of

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appreciation of that bond over ten years while you could attribute 30 bucks a

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year in appreciation each year such that after we'll say three and a half years

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you'd hold the bond as having appreciated 3.5 times 30 bucks or $105 [Straight line appreciation formula appears]

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in appreciation making the bond worth at that point in time eight hundred five

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dollars oh yeah fancy but also pretty easy

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