Accretion Of Discount
Accretion of discount is the increase in the value of a discounted instrument as time passes and the maturity date looms closer. The value of the instrument will accrete (grow) at the interest rate implied by the discounted issuance price, the value at maturity, and the term to maturity.
Definition:
Discount accretion refers to the increase in the value of a discount instrument over time as it approaches its maturity date. The value of the instrument increases based on the discount issuance price, maturity value, and the implied interest rate over the maturity period. Discount instruments typically include Treasury bills, commercial paper, and banker's acceptances.
Origin:
The concept of discount accretion originated from the demand for short-term debt instruments in financial markets. As early as the 19th century, discount instruments were widely used, especially in commerce and banking. With the development of financial markets, the types and applications of discount instruments have gradually diversified.
Categories and Characteristics:
1. Treasury Bills: Issued by the government, high security, low interest rates.
2. Commercial Paper: Issued by corporations, higher risk, higher interest rates.
3. Banker's Acceptances: Accepted by banks, moderate security and interest rates, between Treasury bills and commercial paper.
Specific Cases:
1. Treasury Bill Case: Suppose an investor purchases a one-year Treasury bill with a face value of $1,000 for $950. Over time, the value of this Treasury bill will gradually increase until it reaches $1,000 at maturity.
2. Commercial Paper Case: A company issues a commercial paper with a face value of $10,000 and a six-month maturity, with a discount issuance price of $9,500. After the investor purchases it, the value of this paper will gradually increase as the maturity date approaches, eventually reaching $10,000 at maturity.
Common Questions:
1. What is the formula for calculating discount accretion?
The formula for calculating discount accretion is:
Discount Accretion = Maturity Value - Discount Issuance Price
2. What are the risks associated with discount instruments?
The main risks of discount instruments include credit risk and interest rate risk. Credit risk refers to the risk that the issuer may not be able to repay the principal and interest on time, while interest rate risk refers to the impact of changes in market interest rates on the value of discount instruments.
