How are premium bonds defined and priced?

Premium bonds are defined as bonds that are sold at a price above their face value, which typically occurs when they offer higher coupon rates compared to current market interest rates. When interest rates in the market rise, existing bonds with lower coupon rates become less attractive, leading to a decrease in their price. Conversely, if a bond has a higher coupon rate compared to market rates, investors may be willing to pay more than the face value for it, resulting in the bond being sold at a premium.

This pricing scenario provides an incentive for investors as the higher coupon payments yield a better return compared to the prevailing market rates. The premium price reflects the bond's attractiveness due to its higher fixed interest payments, often appealing to investors seeking income stability. Thus, the relationship between coupon rates and market interest rates fundamentally influences the pricing of premium bonds.