what is an amortizable bond premium 
the amortizable bond premium is a tax term that refers to the excess price paid for a bond over and above its face value depending on the type of bond the premium can be tax deductible and amortized over the life of the bond on a pro rata basis understanding an amortizable bond premiuma bond premium occurs when the price of the bond has increased in the secondary market due to a drop in market interest rates a bond sold at a premium to par has a market price that is above the face value amount the difference between the bond s current price or carrying value and the bond s face value is the premium of the bond for example a bond that has a face value of 1 000 but is sold for 1 050 has a 50 premium over time as the bond premium approaches maturity the value of the bond falls until it is at par on the maturity date the gradual decrease in the value of the bond is called amortization for a bond investor the premium paid for a bond represents part of the cost basis of the bond which is important for tax purposes if the bond pays taxable interest the bondholder can choose to amortize the premium that is use a part of the premium to reduce the amount of interest income included for taxes 1those who invest in taxable premium bonds typically benefit from amortizing the premium because the amount amortized can be used to offset the interest income from the bond this in turn will reduce the amount of taxable income the bond generates and thus any income tax due on it as well the cost basis of the taxable bond is reduced by the amount of premium amortized each year 1in a case where the bond pays tax exempt interest the bond investor must amortize the bond premium although this amortized amount is not deductible in determining taxable income the taxpayer must reduce their basis in the bond by the amortization for the year 1 the irs requires that the constant yield method be used to amortize a bond premium every year 2amortizing bond premium with the constant yield methodthe constant yield method is used to determine the bond premium amortization for each accrual period 2 it amortizes a bond premium by multiplying the adjusted basis by the yield at issuance and then subtracting the coupon interest or in formula form the first step in calculating the premium amortization is to determine the yield to maturity ytm which is the discount rate that equates the present value of all remaining payments to be made on the bond to the basis in the bond 2for example consider an investor that purchased a bond for 10 150 the bond has a five year maturity date and a par value of 10 000 it pays a 5 coupon rate semi annually and has a yield to maturity of 3 5 let s calculate the amortization for the first period and second period since this bond makes semi annual payments the first period is the first six months after which the first coupon payment is made the second period is the next six months after which the investor receives the second coupon payment and so on since we re assuming a six month accrual period the yield and coupon rate will be divided by 2 following our example the yield used to amortize the bond premium is 3 5 2 1 75 and the coupon payment per period is 5 2 x 10 000 250 the amortization for period 1 is as follows the bond s basis for the second period is the purchase price plus the accrual in the first period that is 10 150 72 38 10 077 62 for the remaining eight periods there are 10 accrual or payment periods for a semi annual bond with a maturity of five years use the same structure presented above to calculate the amortizable bond premium intrinsically a bond purchased at a premium has a negative accrual in other words the basis amortizes 