Bond Discount

Definition

Bond Discount refers to the situation where a bond is sold for less than its face (or maturity) value. The difference between the bond’s market price and its higher face value constitutes the bond discount. A bond may be issued at a discount, or a discount may arise due to an increase in general interest rates or perceived risk of default. The discount is gradually realized as income by the bondholder, along with periodic interest payments, as the bond approaches maturity.

Examples

1. Issued at a Discount: A corporation issues a $1,000 face value bond for $950. The bond is sold at a $50 discount.
2. Market Conditions: An existing $1,000 face value bond trades in the market at $920 due to rising interest rates. The bondholder realizes an $80 discount at maturity.
3. Zero Coupon Bond: A zero coupon bond with a face value of $1,000 is sold for $700 because it pays no periodic interest. The bond discount of $300 is the income realized by the bond holder upon maturity.

Frequently Asked Questions (FAQs)

Q1: Why do bonds sell at a discount? A1: Bonds sell at a discount typically due to rising interest rates that make existing bonds with lower rates less attractive or because of perceived increased risk of default from the issuer.

Q2: How does a bond discount affect yield? A2: A bond discount increases the effective yield of the bond because the investor earns not only the regular interest payments but also the amount of the discount upon maturity.

Q3: What is the difference between a bond discount and a bond premium? A3: A bond discount occurs when a bond sells for less than its face value, whereas a bond premium occurs when a bond sells for more than its face value.

Q4: How is the bond discount recorded in accounting? A4: The bond discount is amortized over the life of the bond using methods like the straight-line method or the effective interest rate method, and this amortization is recorded as an increase in interest expense.

Q5: Are zero coupon bonds always issued at a discount? A5: Yes, zero coupon bonds are always issued at a discount because they do not provide periodic interest payments and the investor’s return is the difference between the purchase price and the maturity value.

Related Terms

• Face Value: The nominal or dollar value of a bond that is paid to the bondholder at maturity.
• Zero Coupon Bond: A bond that is issued at a significant discount from its face value and does not make regular interest payments but rather pays the full face value at maturity.
• Yield to Maturity (YTM): The total return anticipated on a bond if it is held until it matures, including interest payments and amortization of any premium or discount.
• Interest Rate Risk: The risk that changes in interest rates will affect the value of bonds, causing them to trade at a discount or premium.

Online References

1. Investopedia - Bond Discount
2. Wikipedia - Bonds (Finance)
3. SEC - Investing in Bonds

Suggested Books for Further Studies

1. “The Bond Book: Everything Investors Need to Know About Treasuries, Municipals, GNMAs, Corporates, Zeros, Bond Funds, Money Market Funds, and More” by Annette Thau.
2. “Bonds: An Introduction to the Core Concepts” by Mark Mobius.
3. “Bond Markets, Analysis, and Strategies” by Frank J. Fabozzi.
4. “Fixed Income Securities: Tools for Today’s Markets” by Bruce Tuckman.

Fundamentals of Bond Discount: Finance Basics Quiz

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