Bond Premium

### What is a bond premium? - [x] The amount paid over the bond’s face value. - [ ] The amount paid under the bond’s face value. - [ ] A discount on the bond’s face value. - [ ] Not related to bond transactions. > **Explanation:** A bond premium is when an investor pays more than the bond’s face value due to a higher coupon rate than the prevailing market interest rates. ### Can the premium on taxable bonds be amortized? - [x] Yes, it can be amortized. - [ ] No, it cannot be amortized. - [ ] Only if the bond is held until maturity. - [ ] Only after five years. > **Explanation:** Premium on taxable bonds can be amortized, which helps in reducing the annual taxable interest income. ### How does amortizing the bond premium affect interest income? - [ ] Increases taxable interest income. - [x] Decreases taxable interest income. - [ ] Leaves taxable interest income unchanged. - [ ] Only affects capital gains. > **Explanation:** Amortizing the bond premium reduces the bondholder’s taxable interest income by partially offsetting the high coupon payments. ### Is bond premium amortization allowed for tax-exempt bonds? - [ ] Yes, it is allowed. - [x] No, it is not allowed. - [ ] Depends on the state laws. - [ ] Only for government bonds. > **Explanation:** Amortization of bond premiums for tax-exempt bonds is not allowed for tax purposes. ### Why might investors purchase bonds at a premium? - [x] Due to high coupon rates. - [ ] Due to lower risk. - [ ] To pay less in taxes. - [ ] Because of market inefficiency. > **Explanation:** Investors purchase bonds at a premium primarily to benefit from the higher-than-market coupon rates, leading to greater periodic interest income. ### What must happen if a bond sold before maturity still has unamortized premium? - [x] It adjusts the bond’s basis. - [ ] It remains as a loss. - [ ] It is written off. - [ ] It gets refunded. > **Explanation:** If a bond is sold before maturity, any remaining unamortized premium adjusts the bond's cost basis, impacting the sales gain or loss. ### Why is the bond premium amortization process significant? - [ ] It decreases bond duration. - [ ] It avoids call risk. - [x] It aligns reported interest income with actual yield. - [ ] It eliminates credit risk. > **Explanation:** Bond premium amortization aligns the reported interest income with the bond’s yield to maturity, providing a more accurate financial reflection. ### Can bond premiums affect the bond’s yield to maturity? - [x] Yes. - [ ] No. - [ ] Only for callable bonds. - [ ] Only for zero-coupon bonds. > **Explanation:** Bond premiums affect the bond’s yield to maturity as they adjust the effective return to match the market interest rates over the bond’s remaining life. ### When must an investor elect to amortize a bond premium? - [x] At the time of bond purchase. - [ ] At year-end tax filing. - [ ] After holding for over one year. - [ ] Whenever capital gains arise. > **Explanation:** Investors must typically elect to amortize a bond premium at the time of bond purchase and must apply this election consistently. ### What is the main reason for amortizing bond premiums? - [ ] Increase interest payments. - [ ] Shorten bond maturity. - [x] Reduce taxable interest income. - [ ] Lower bond price. > **Explanation:** The main reason for amortizing bond premiums is to reduce taxable interest income, aligning it closer to the actual yield of the bond.