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Jose Alberto Fuentes Group

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Hunter Sanders
Hunter Sanders

How To Buy Premium Bonds


Many bond investors do not like the idea of purchasing a premium bond, or a bond that is priced at more than its principal amount. They would rather buy a bond at a discount or at par value because it looks like the "better deal." Contrary to popular opinion, premium bonds can actually be advantageous to the investor.




how to buy premium bonds



Although paying a premium for a bond at the time of the purchase may seem unattractive, that outflow of cash that was spent is recouped through higher coupon payments over time. Premium bonds are attractive for their high coupon rates that are greater than current market yields. In other words, the higher initial cost can be offset by the higher cash payments received throughout the life of the bond.


Let's examine how a premium bond can be more beneficial than a discount bond. In this example, we have two 10-year bonds, each with a face value of $1,000. One bond is priced at a discount while the other is priced at a premium.


Premium bonds offer both novice and experienced investors the security of a government-backed savings account, with the chance to win up to 1million each month. We look into more detail about how premium bonds work and whether you should invest in them below.


A bond that trades above its par value is called a premium bond. A bond that trades below its par value is called a discount bond. If two bonds have the same maturity and the same credit risk, the bond with the higher coupon rate will trade at a higher price. If a bond is trading at a premium, it means the coupon rate of the bond is above current market interest rates. The fixed income market is efficient and will adjust the trading prices of two different bonds with two different coupon rates such that the return will be roughly the same when the bond matures.


The strategy of buying premium bonds when interest rates are rising works well with agency bullets (noncallable bonds) and U.S. Treasury notes. A credit union should be more cautious when buying callable bonds and amortizing mortgage-backed securities (MBS) at significant premiums.


Credit union earnings margins should benefit from rising interest rates in 2022, but higher rates can create challenges in investment portfolios. Favoring higher coupons and premium noncallable bonds can help lower interest rate risk in the investment portfolio and will provide greater future cash flows to be reinvested as interest rates rise.


The principle behind Premium Bonds is that rather than the stake being gambled, as in a usual lottery, it is the interest on the bonds that is distributed by a lottery. The bonds are entered in a monthly prize draw and the government promises to buy them back, on request, for their original price.


Investors can buy bonds at any time but they must be held for a whole calendar month before they qualify for a prize. As an example, a bond purchased mid-May must then be held throughout June before being eligible for the draw in July (and onwards). Bonds purchased by reinvestment of prizes are immediately eligible for the following month's draw.


Numbers are entered in the draw each month, with an equal chance of winning, until the bond is cashed. As of 2019, each person may own bonds up to 50,000.[4] Since 1 February 2019, the minimum purchase amount for Premium Bonds has been 25. As of April 2023[update] there are over 86 billion eligible Premium Bonds, each having a value of 1.[5]


In August 2004, ERNIE 4 was brought into service in anticipation of an increase in prizes each month from September 2004.[3] Developed by LogicaCMG, it was 500 times faster than the original and generated a million numbers an hour; these were checked against a list of valid bonds. By comparison, the original ERNIE generated 2,000 numbers an hour and was the size of a van.[3]


In December 2008, NS&I reduced the interest rate (and therefore the odds of winning) due to the drop in the Bank of England base rate during the credit crunch, leading to criticism from members of Parliament, financial experts and holders of bonds; many claimed Premium Bonds were now "worthless", and somebody with 30,000 invested and "average luck" would win only 10 prizes a year compared to 15 the previous year.[19][20] Investors with smaller, although significant, amounts would possibly win nothing.


With odds as of January 2023 of 1/24000,[23] the expected number of prizes for the maximum 50,000 worth of bonds is 25 per year. The calculation is 1/24000 x 12 (draws per year) x 50,000 (number of bonds held). Assuming a most likely return of 13 x 25, 6 x 100 and 5x 50 prizes; the other one being much less likely, this is an effective interest rate of 2.35%.


The prize fund is equal to one month's interest on all bonds eligible for the draw. The annual interest is set by NS&I and was 1.40% as of December 2017[update], reducing to 1.00% as of December 2020[update]. This was increased to 2.2% as of October 2022[update] and increased again to 3% as of January 2023[update].[24] The following table lists the distribution of prizes on offer in the January 2023 draw.[25]


Aaron Brown discusses in a 2006 book Premium Bonds in comparison with equity-linked, commodity-linked and other "added risk" bonds.[34] His conclusion is that it makes little difference, either to a retail investor or from a theoretical finance perspective, whether the added risk comes from a random number generator or from fluctuations in financial markets.


In many cases we prefer individual bonds over bond funds or bond exchange-traded funds. Our bond traders are accustomed to dealing with premium and discount bonds, as well as the different calculations needed when purchasing bonds on the secondary market.


Individual bonds do come with their own risks. Corporations and municipalities can run into financial trouble. Any bond portfolio should be reviewed on a regular basis. Keeping an eye on price fluctuations and ratings changes below investment grade can help to avoid larger problems down the road.


The California Department of Insurance (CDI) has regulated the bail bond business since the passage of the Bail Bond Regulatory Act in 1937. A bail bond is a surety bond, which is posted by a bail bond company to the court as a guarantee for an arrestee's appearance at all court dates. The court will release an arrestee from detention upon posting of the bail bond. Bail bonds are underwritten and issued by licensed bail agents which act as the appointed representatives of licensed surety insurance companies.


OID is a form of interest. It is the excess of a debt instrument's stated redemption price at maturity over its issue price (acquisition price for a stripped bond or coupon). Zero coupon bonds and debt instruments that pay no stated interest until maturity are examples of debt instruments that have OID.


This section is for persons who prepare their own tax returns. It discusses the income tax rules for figuring and reporting OID on long-term debt instruments. It also includes a similar discussion for stripped bonds and coupons, such as zero coupon bonds available through the Department of the Treasury's STRIPS program and government-sponsored enterprises such as the Resolution Funding Corporation. However, the information provided does not cover every situation. More information can be found in Regulations under sections 1271 through 1275.


If you strip one or more coupons from a bond and then sell or otherwise dispose of the bond or the stripped coupons, they are treated as separate debt instruments issued with OID. The holder of a stripped bond has the right to receive the principal (redemption price) payment. The holder of a stripped coupon has the right to receive an interest payment on the bond. The rule requiring the holder of a debt instrument issued with OID to include the OID in gross income as it accrues applies to stripped bonds and coupons acquired after July 1, 1982. See Debt Instruments and Coupons Purchased After July 1, 1982, and Before 1985 or Debt Instruments and Coupons Purchased After 1984, later, for information about figuring the OID to report.


Debt instruments backed by U.S. Treasury securities that represent ownership interests in those securities. Examples include obligations backed by U.S. Treasury bonds that are offered primarily by brokerage firms (variously called CATS, TIGRs, etc.).


None of the OID on bonds or coupons acquired before this date is taxable. The accrued OID is added to the basis of the bond or coupon. The accrued OID is the amount that produces a YTM, based on your purchase date and purchase price, equal to the lower of the following rates.


Summary: This is the calculation used for figuring the yield to maturity of bonds and coupons purchased after 7/1/82 and before 1985. This calculation can only be used if the period from purchase to maturity can be divided exactly into full accrual periods. To calculate: (s.r.p. divided by a.p.) raised to the (1 divided by m) power minus 1: where: s.r.p. is the stated redemption price at maturity; a.p. is the acquisition price; m is number of full accrual periods from purchase to maturity.


Summary: This is the calculation used for figuring the yield to maturity of bonds and coupons purchased after 1984. This calculation can only be used if the period from purchase to maturity can be divided exactly into full accrual periods. To calculate: n multiplied by ((s.r.p. divided by a.p.) raised to the (1 divided by m) power minus 1): where: n is the number of accrual periods in one year, s.r.p. is the stated redemption price at maturity; a.p. is the acquisition price; and m is number of full accrual periods from purchase to maturity.


Summary: This is the calculation used for figuring the yield to maturity of bonds and coupons purchased after 1984 as described in example 11. To calculate: 2 multiplied by (($100,000 divided by $38,000) raised to (1 divided by 25) power minus 1) equals 2 multiplied by (1.03946 minus 1) equals 0.07892 equals 7.892%. 041b061a72


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