Discount Bond

Definition

A discount bond is a bond issued at a price lower than its face or par value. These bonds can also be traded in the secondary market at a price below par. If a bond is sold at a price significantly below its face value, typically 20% or more, it is considered a deep discount bond. Discount bonds are the opposite of premium bonds.

Origin

The concept of discount bonds originated with the development of the bond market, particularly when governments and corporations needed to raise funds by issuing bonds. Historically, the use of discount bonds can be traced back to the 19th century when governments began issuing bonds at prices below par to attract investors.

Categories and Features

Discount bonds can be categorized into regular discount bonds and deep discount bonds. Regular discount bonds are issued slightly below par value, while deep discount bonds are priced significantly below par. The main feature of discount bonds is that investors receive the full par value at maturity, thus realizing capital appreciation. The advantage is the lower initial investment, but the disadvantage is that if market interest rates rise, the bond's price may fall further.

Case Studies

A typical example is the U.S. Treasury's issuance of short-term Treasury bills, which are often issued at a discount and redeemed at par value upon maturity. Another example is certain corporate bonds that trade at a discount when market interest rates rise, such as during the 2008 financial crisis when many corporate bond prices fell significantly, becoming discount bonds.

Common Issues

Investors may face issues such as price volatility due to changes in market interest rates and the credit risk of the bond issuer when purchasing discount bonds. A common misconception is that discount bonds are always riskier than par bonds, but in reality, the risk depends on the issuer's creditworthiness and market conditions.