SIE practice questionhardBond Premium Amortization
An investor purchases a corporate bond at a premium. How does the premium affect the investor's cost basis over time?
- AThe cost basis increases each year until maturity
- BThe cost basis decreases each year as the premium is amortized toward par✓ Correct answer
- CThe premium is immediately deducted from the investor's income
- DThe cost basis remains unchanged until the bond is sold
Explanation
Why B — The cost basis decreases each year as the premium is amortized toward par
When a bond is purchased at a premium, the investor may amortize the premium over the remaining life of the bond (and must do so for tax-exempt bonds). This gradually reduces the cost basis toward par value. Each year, the amortized portion reduces the investor's taxable interest income. At maturity, the cost basis equals par, so there is no capital loss. For taxable bonds, premium amortization is optional but generally beneficial.
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