Amortizing a premium bond recognizes that a bond priced higher than par must eventually be redeemed at par when it matures. An acceptable form of an amortization table can be created through straight line amortization or by the use of a bond calculator. The entire amortization table can be created on the day the bond is purchased. Required information includes the maturity, price and call feature. Premium amortization on taxable bonds reduces income tax as the premium may be deducted against income.
Study the final confirmation slip that came from your bond broker after buying the bond. Find the confirmation date of the trade (the date money was exchanged for the bond), the call feature, including any premium or par call, and the maturity date of the bond. All bonds are redeemed at par at maturity. Enter this data along with the cost of the bond on the spreadsheet program.
Use the straight line method of amortization. Subtract the bond purchase price from the first call price and then divide the results by the time difference. For example, a bond purchased at 106 has a 3 year 102 call and 6 years to maturity. The annual straight line amortization is 106 minus 102 or 4 divided by three years. The result is 1.33 points of amortization each year to the call.
Subtract the call price from par. If the bond is not called, continue the amortization from the call date to maturity. Using the example from Step 2, 102 minus 100 is 2. 2 divided by 3 years is .67. Each year after the call, reduce the value of the bond by .67. At maturity the bond will be fully amortized.
Employ the bond calculator to compute the amortization schedule (see Resources for link). Enter the coupon, bond price, call date maturity date and trade date. Advance the trade date to Jan. 1 of each year remaining on the bond life. The difference between the current and previous bond prices is the amount of amortization. Either method of amortization described in this article is recognized for tax purposes.
Trade bonds for gains or tax losses. Be aware that trading before maturity requires you not to use the cost of any premium bond but the amortized cost of the bond. If the bond is sold above your amortized cost, not your original cost, you may be liable for capital gains tax on the profit. Consult an accounting professional for advice on your individual situation.
If the bond was purchased below par (100), you have purchased a discount bond, not a premium bond. You will need to accrete the bond price, not amortize it.
- If the bond was purchased below par (100), you have purchased a discount bond, not a premium bond. You will need to accrete the bond price, not amortize it.
After an 18-year career on Wall Street as a trader of municipal and mortgage backed securities, Carmelo Montalbano developed a very large desktop trading application that managed more than 30 institutional portfolios. Technology and small business acquisitions continue to be his primary interest.