Premium Definition. A Premium has various meanings based on the investment vehicle that provides the context for the term. In forex markets, a premium equates to the amount by which the forward or futures price exceeds the spot price. It can also refer to the total cost of an option. Since an option has no intrinsic value, its value depends on market valuation of the underlying asset. If the option is “In the Money”, the value appreciation less the premium initially expended constitutes the holder’s paper gain, unless it is realized through a sale. If there is no possibility for gain, when the option expires, the loss is limited to the amount of the premium. In the case of bonds, a premium represents the difference between the higher price paid for bond and the bond’s face amount at issue. A bond typically changes in face value in a trading market due to changes in prevailing interest rates. A bond will increase in value if interest rates decline, and decline in value when interest rates rise. In many cases, investors misunderstand this property of bonds since bonds are commonly referred to as “fixed income securities”. As for futures and options, volatility in the market will also impact the pricing of the financial instrument.
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