Unamortized Bond Premium

What Is Unamortized Bond Premium?

An unamortized bond premium alludes to the difference between a bond's face value and its sale price. On the off chance that a bond is sold at a discount, for example, at 90 pennies on the dollar, the issuer must in any case repay the full 100 pennies of face value at par. Since this interest amount has not yet been paid to bondholders, it is a liability for the issuer.

Grasping Unamortized Bond Premium

The bond premium is the excess amount that the bond is priced at over its face value. While winning interest rates in the economy decline, the price of bonds increase. This is on the grounds that the market interest rate becomes lower than the fixed coupon rate on outstanding bonds.

Since bondholders are holding higher-interest paying bonds, they require a premium as compensation in the market. The unamortized bond premium remaining parts of the bond premium that the issuer has not yet written off as an interest expense.

For instance, we should expect that when interest rates were 5% a bond issuer sold bonds with a 5% fixed coupon to be paid every year. After a period of time, interest rates declined to 4%. New bond issuers will issue bonds with the lower interest rate. Investors who would prefer to buy a bond with a higher coupon should pay a premium to the higher-coupon bondholders to boost them to sell their bonds. In this case, assuming that the bond's face value is $1,000 and the bond sells for $1,090 after interest rates decline, the difference between the selling price and par value is the unamortized bond premium ($90).

The unamortized bond premium is the part of the bond premium that will be amortized (written off) against expenses from now on. The amortized amount of this bond is credited as a interest expense. Assuming that the bond pays taxable interest, the bondholder can decide to amortize the premium, that is, utilize a part of the premium to reduce the amount of interest income included for taxes.

Special Considerations

The people who invest in taxable premium bonds commonly benefit from amortizing the premium, on the grounds that the amount amortized can be utilized to offset the interest income from the bond, which will reduce the amount of taxable income the investor should pay with respect to the bond. The cost basis of the taxable bond is reduced by the amount of premium amortized every year.

In a case wherein the bond pays tax-exempt interest, the bond investor must amortize the bond premium. Albeit this amortized amount isn't deductible in deciding taxable income, the taxpayer must reduce their basis in the bond by the amortization for the year.

An unamortized bond premium is reserved as a liability to the bond issuer. On an issuers balance sheet, this thing is kept in a special account called the Unamortized Bond Premium Account. This account perceives the excess amount of bond premium that the bond issuer has not yet amortized or charged off to interest expense over the life of the bond.

Model: Unamortized Bond Premium Calculation

To work out the amount to be amortized for the tax year, the bond price is increased by the yield to maturity (YTM), the consequence of which is deducted from the coupon rate of the bond. Utilizing the model over, the yield to maturity is 4%.

Duplicating the selling price of the bond by the YTM yields $1,090 x 4% = $43.60.
This value when deducted from the coupon amount (5% coupon rate x $1,000 par value = $50) results in $50 - $43.60 = $6.40, which is the amortizable amount.
For tax purposes, a bondholder can reduce their $50 interest income to $50 - $6.40 = $43.60.
The unamortized premium following a year is $90 bond premium - $6.40 amortized amount = $83.60.
For the second tax year, $6.40 of the bond premium has previously been amortized, so the bond's cost basis is $1,090 - $6.40 = $1,083.60.
Premium amortization for Year 2 = $50 - ($1,083.60 x 4%) = $50 - $43.34 = $6.64.
Premium excess after the subsequent year or the unamortized premium is $83.60 - $6.64 = $76.96.

Expecting the bond develops in five years, you can run similar calculation for the leftover three years. For example, the bond's cost basis in the third year will be $1,083.60 - $6.64 = $1,076.96.

Features

An unamortized bond premium is a liability for issuers as they have not yet written off this interest expense, yet will ultimately come due.
An unamortized bond premium is the net difference in the price that a bond issuer sells securities less the bonds' real face value at maturity.
On financial statements, unamortized bond premium is kept in a liability account called the Unamortized Bond Premium Account.