Discount Bond

A discount bond is a bond sold for less than its face value or par value. When the bond matures, the investor receives the face value of the bond. Discount bonds can be treasury, municipal, corporate, etc. They offer a way for the issuer to raise capital by selling at a reduced price.
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Definition

A discount bond is a type of bond that is sold to investors at a price lower than its face value or par value. The face value is the amount paid back to the bondholder at maturity. For instance, an investor may purchase a bond with a face value of $1,000 for $950. When the bond matures, the investor receives the full $1,000, earning a profit of $50.

Examples

  1. Treasury Bills (T-Bills): These are short-term government securities sold at a discount from the face value. For example, a $10,000 T-Bill might be sold for $9,800, and the investor will receive $10,000 at maturity.

  2. Zero Coupon Bonds: These bonds do not pay periodic interest and are sold at a deep discount, accruing interest that compounds to be paid at maturity. For example, a $5,000 zero-coupon bond might be sold for $3,500.

  3. Corporate Bonds: A company might issue a $1,000 face value bond at a discount for $970 to incentivize investors when market interest rates are higher than the bond’s coupon rate.

Frequently Asked Questions

Q1: Why do companies issue discount bonds?

A1: Companies issue discount bonds to attract investors when market interest rates are higher than the bond’s coupon rate or to raise capital quickly.

Q2: How do investors profit from discount bonds?

A2: Investors profit by buying the bond at a price below its face value and receiving the face value at maturity, or through price appreciation if the bond is sold before maturity.

Q3: What are the risks associated with discount bonds?

A3: Risks include interest rate risk, where rising rates can decrease bond prices, and default risk, where the issuer might fail to pay back the face value.

Q4: Are taxes applicable on the profits from discount bonds?

A4: Yes, the profit made from the difference between the purchase price and the face value is typically subject to capital gains tax, and specific rules depend on the jurisdiction.

Q5: Can discount bonds be bought and sold in the secondary market?

A5: Yes, discount bonds can be traded on the secondary market, where their prices may fluctuate based on interest rates and market demand.

  • Bond Discount: The difference between a bond’s face value and its selling price when sold for less than face value.

  • Zero Coupon Bond: A bond sold at a deep discount that doesn’t pay periodic interest, instead providing its return at maturity.

  • Face Value (Par Value): The amount paid to the bondholder at maturity.

  • Yield to Maturity (YTM): The total return anticipated on a bond if held until it matures.

  • Coupon Rate: The annual interest rate paid on a bond’s face value.

  1. Investopedia: Discount Bond
  2. U.S. Securities and Exchange Commission
  3. Bloomberg Markets
  4. Federal Reserve Bank

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. “Bond Markets, Analysis, and Strategies” by Frank J. Fabozzi
  3. “Fixed Income Analysis” by Barbara S. Petitt and Jerald E. Pinto

Fundamentals of Discount Bonds: Finance Basics Quiz

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