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.
