Amortizable Bond Premium – Definition

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Amortizable Bond Premium Definition

Amortizable Bond Premium refers to the cost of premium paid above the face value of a bond. The face value of a bond is also called “par value”, it is the original cost of a stock or the amount paid to the holder of a bond.

Amortizable Bond Premium is the difference (excess premium) between the amount a bond is purchased and the face value/par value of the bond. Any excess amount paid for a bond which is over and above its face value is amortizable bond premium.

A Little More on What is Amortizable Bond Premium

Usually, the face value or par value of a bond is $1,000, any amount paid for a bond more than this value describes the premium of the bond. A bond sold at $1,100 as against its original price of $1,000 has a $100 as its premium. Amortization on the other hand is a gradual decrease in the value of a bond before its maturity date.

The premium of a bond is calculated as part of its cost basis. A bondholder then decides whether to amortize the premium of he invested in a taxable premium bond. If amortized, this amount can counterbalance an investor’s taxable income. In cases of tax-exempt bonds, an amortized amount cannot offset the taxable income.

The Internal Revenue Service requires that amortizable Bond Premium for every accrual year is calculated using the constant yield method, this method is regarded as an effective or scientific method of amortization.

The constant yield method uses the formula;

Accrual = Purchase Basis x (YTM /Accrual periods per year) – Coupon Interest

It means multiplying the adjusted basis by the yield at issuance and then subtracting the coupon interest. In calculating the premium amortization the YTM (yield to maturity) of the bond must be outlined. YTM is the discount rate that equates the present value of all remaining payments to be made on a bond. Using the constant yield method aids an accurate calculation of amortizable bond premium.

References for Bond Amortization

Academic Research on Amortization of Bond Premium

The pricing of premium bonds, Livingston, M. (1979). Journal of Financial and Quantitative Analysis, 14(3), 517-527.

Depreciation of Property Acquired Subject to a Lease: Premium Lease Rentals as a Wasting Asset, Quilliam Jr, W. R. (1969). Val. UL Rev., 4, 261.

Say good-bye to pooling and goodwill amortization, Moehrle, S. R., & Reynolds-Moehrle, J. A. (2001). Journal of Accountancy, 192(3), 31.

The capitalization, amortization, and value-relevance of R&D, Lev, B., & Sougiannis, T. (1996). Journal of accounting and economics, 21(1), 107-138.

Establishing an Interest-Free Lending Platform Applying Optimum Premium,’Mesbah Point,’in Amortization and Time Value of Money, Izadyar, A., & Ragnath, F. (2014).

Amortization, and the Problem of Discount Bonds in Trust Accounting, Black, G. K. (1941). BUL Rev., 21, 305.

The other side of value: The gross profitability premium, Novy-Marx, R. (2013). Journal of Financial Economics, 108(1), 1-28.

A note on cash flow and classification patterns of financial ratsios, Gombola, M. J., & Ketz, J. E. (1983). Accounting Review, 105-114

Premium and discount securities: Relative tax advantage under the Deficit Reduction Act of 1984, Arak, M., Goodman, L., & Silver, A. (1986). National Tax Journal, 65-77.

Interest on Investments, and Amortization of Premiums Paid and Accumulation of Discounts Allowed Thereon, Vierling, F. K. (1920). Louis L. Rev., 5, 134.

Amortization-An Unsettled Question in Trust Accounting, Black, G. K. (1931). Mass. LQ, 17, 81.

Taxation, Negative Amortization and Affordable Mortgages, Knoll, M. S. (1992). Ohio St. LJ, 53, 1341.

 

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