What is a bonus?
Premium has several meanings in finance, the first being the total cost of purchasing an option. A premium is also the difference between the price paid for a fixed income security and the nominal value of the security in question. Finally, the premium is also the specified payment amount required periodically by an insurer to provide coverage under a given insurance plan for a defined period of time.
Key points to remember
- The premium can mean a number of things in finance, including the cost of purchasing an option.
- The premium is also the price of a bond higher than its issue price.
- The premium is also considered to be the periodic payment required for insurance coverage.
Premiums for options are the cost of purchasing an option. Options give the holder (owner) the right, but not the obligation, to buy or sell the underlying financial instrument at a specified strike price. The bond premium reflects changes in interest rates or the risk profile since the date of issue.
The insurance premium includes the indemnities paid to the insurer to bear the payment risk in the event of an event that triggers coverage. The most common types of coverage are auto, health and homeowners insurance.
Types of bonus
The buyer of an option has the right but not the obligation to buy (call) or sell (put) the underlying instrument at a given exercise price for a given period. The premium paid is its intrinsic value plus its time value; an option with a longer maturity always costs more than the same structure with a shorter maturity. Market volatility and the proximity of the strike price to the then prevailing market price also affect the premium.
Sophisticated investors sometimes sell an option (also known as an option subscription) and use the premium received to cover the cost of buying the underlying instrument or another option. Purchasing multiple options may increase or decrease the risk profile of the position, depending on its structure.
Bond price premium
The concept of a bond price premium is directly linked to the principle that the price of a bond is inversely linked to interest rates; if a fixed income security is purchased at a premium, this means that the interest rates then in effect are lower than the coupon coupon rate. The investor thus pays a premium for an investment which will yield an amount higher than the existing interest rates.
Premiums are paid for many types of insurance, including health insurance, homeowners and rental insurance. A common example of an insurance premium comes from auto insurance. A vehicle owner can insure the value of their vehicle against loss due to accident, theft, fire and other potential problems.
The owner usually pays a fixed premium amount in exchange for the insurance company’s guarantee to cover the economic losses suffered under the agreement. Premiums are based on both the risk associated with the insured and the desired amount of coverage.