Definition:

A bond discount occurs when a bond is purchased for a price below its face value. This happens when the market interest rate is higher than the coupon rate on the bond.

Key points about bond discounts:

  • Purchase price: A bond discount means the purchase price is less than the face value.
  • Accretion: The discount is amortized over the life of the bond, increasing its carrying value.
  • Interest income: The interest income from a bond 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 do bond discounts occur?

  • Interest rate changes: If market interest rates rise after a bond is issued, the bond’s market price will fall, creating a discount.
  • Credit risk: If the creditworthiness of the issuer declines, the bond’s market price may fall, creating a discount.

In essence, a bond discount is a situation where a bond is purchased at a price below its face value, and it results in additional interest income over the life of the bond.