Definition:
A bond issued at a discount occurs when the purchase price of a bond is less than its face value. This happens when the market interest rate is higher than the coupon rate on the bond. For example, if a bond with a face value of $1,000 is purchased for $900, it is said to be issued at a discount of $100.
Key points about bonds issued at a discount:
- Market interest rates: The discount occurs when market interest rates rise after the bond is issued, making the bond’s fixed coupon rate less attractive to investors.
- Accretion: The discount is amortized over the life of the bond, increasing its carrying value.
- Interest income: The interest income from a bond issued at a discount consists of the coupon payments plus the accretion of the discount.
- Tax implications: The accretion of the discount is treated as taxable interest income.
Why are bonds issued at a discount attractive to investors?
- Higher yield: Bonds issued at a discount offer a higher yield to maturity than bonds issued at par or a premium.
- Capital appreciation: In addition to the coupon payments, investors can also benefit from the appreciation of the bond’s value as the discount is amortized.
In essence, a bond issued at a discount is a bond that is purchased for a price below its face value, and it offers investors the potential for higher returns due to the accretion of the discount.
