2.2 Bond Pricing: Par, Premium, and Discount

Par, premium, and discount in one rule

Every conventional fixed-rate bond has a face value (also called par value or principal)—the amount the issuer promises to repay at maturity. Secondary-market price can sit at, above, or below that face value. The classification depends on how the bond’s coupon rate compares with the market yield required on similar bonds today:

Memorize the middle column as a decision tree: compare coupon to yield first; the price label follows.

Why the market forces these prices

Investors always have an alternative: buy a newly issued bond whose coupon is set near today’s market yield, or buy an older bond with a different coupon in the secondary market. Arbitrage-style competition equalizes expected returns (adjusting for credit, liquidity, and tax features).

• If an old bond pays more coupon income than new bonds of similar risk, demand pushes its price up until the extra cash flows are offset by buying above face (and receiving only face at maturity).
• If an old bond pays less coupon income than new bonds, its price must fall so the buyer also earns a capital gain as price recovers toward face (or simply so the lower purchase price raises the effective yield).

Credit quality still matters for the level of the market yield, but “premium” does not mean “high quality” and “discount” does not mean “distressed.” A top-rated Philippine government bond can trade at a discount purely because rates rose after it was issued.

Philippine peso examples

Assume face value PHP 100,000 for a straight fixed-rate peso bond (ignore accrued interest and day-count conventions for conceptual UCP questions).

Case 1 — Par

• Coupon rate: 6.00% → annual coupon PHP 6,000
• Market yield for similar bonds: 6.00%
• Price: about PHP 100,000 (par)

The bond pays exactly what the market currently demands, so there is no need to bid above or below face.

Case 2 — Premium

• Same bond, still coupon 6.00% (PHP 6,000 per year)
• Market yields fall to 4.50% after BSP easing and lower inflation expectations
• Investors bid the price to, for example, PHP 108,000 (premium)

Why pay PHP 108,000 for PHP 100,000 of face? Because PHP 6,000 of annual coupon is attractive versus new 4.50% issues. Over the remaining life, part of that advantage is “paid for” up front through the premium. If held to maturity, the holder receives only PHP 100,000 of principal back, realizing a capital loss of PHP 8,000 that offsets the rich coupons—this is normal premium-bond economics, not a penalty.

Case 3 — Discount

• Same 6.00% coupon bond
• Market yields rise to 7.50%
• Price falls to, for example, PHP 93,000 (discount)

The coupon is now below what new bonds pay. The lower purchase price raises the buyer’s overall expected return toward 7.50%. Holding to maturity, the investor receives PHP 100,000 face, a capital gain of PHP 7,000 that helps compensate for the below-market coupon along the way.

Snapshot table

Exact prices depend on maturity, payment frequency, and yield curve shape; the UCP cares that you classify direction correctly and explain the coupon-vs-yield logic.

Clean price, dirty price, and UITF valuation (awareness)

In professional markets, quotes may separate clean price (quoted without accrued interest) from dirty / full price (clean price plus accrued interest since the last coupon). UITF trustees use fair-value policies consistent with plan rules and applicable accounting standards when marking portfolios. For exam purposes:

• Focus on par / premium / discount vs face from coupon vs yield.
• Remember that fund NAVPU reflects the current market values of holdings, not original purchase cost of each bond.
• A fund can hold a mix of premium and discount bonds at the same time if they were issued in different rate regimes.

Pull to par

As maturity approaches, and if the issuer is expected to pay face in full, a premium bond’s price tends to decline toward par and a discount bond’s price tends to rise toward par, holding credit and yields constant. This pull to par means time itself changes price paths even without a new BSP announcement. Marketing staff should not imply that today’s premium will last forever or that a deep discount automatically means a permanent bargain without discussing remaining life, reinvestment, and yield moves.

Issuance price vs secondary price

Treasury auctions and reopening mechanics can be more detailed than the exam requires; what matters is that secondary-market revaluation, not the original issue ceremony, drives day-to-day UITF marks.

Connecting to client suitability

When presenting a bond or fixed-income UITF:

• A client who may redeem in the short term is exposed to premium/discount volatility—buying after a rate decline (many holdings at premium) still leaves downside if rates reverse upward.
• A client comforted by “the bond will mature at par” may be thinking of a single bond held to maturity, not a UITF unit that can be redeemed daily/weekly at NAVPU.
• Never equate “trading at a discount” with “unsafe issuer” without separate credit analysis; government securities can trade at discounts for pure rate reasons.

Exam traps for this section

1. Mixing up the inequalities — premium is coupon above yield, not below.
2. Thinking discount always means credit trouble — rate increases create discounts on high-grade bonds.
3. Believing price stays at issue price — secondary markets reprice continuously.
4. Assuming premium bonds are “better” — they pay higher coupons but start above face; total return depends on yield and holding period.
5. Forgetting pull to par — premiums erode and discounts accrete toward face as maturity nears if yields and credit stay stable.

Quick self-check

Ask: “Is this bond’s coupon higher than, equal to, or lower than what similar bonds yield today?”
Higher → premium price. Equal → par. Lower → discount price.