Definition: A bond whose market value has fallen below the amount the investor initially loaned to the company in return for receiving the bond. The loan amount goes by many names, including face value and par value, and is usually $1,000. See Bond for an important introduction to bonds.
This term may also be used to describe a bond that is selling for less than face value by design, as in the case of a Zero-coupon bond.
Example: In August of 1994, casino company MGM Mirage issued a $1,000 face value bond due in September of 2012. By March of 2010, it was trading for $977.50, making it at that time a discount bond.
Investeach explains: An investor exchanges $1,000 (the typical face value of a bond) when it is issued. At the maturity date, which can be decades later, the investor who owns it turns it in and receives the $1,000 face value back. Between these two dates, the bond’s market value can fluctuate.
There are two basic reasons why a bond might sell below its face value. Interest rates could have risen during that time, meaning that investors can buy new bonds paying higher rates. For example, if an existing 5% bond was offered for sale, investors wouldn’t agree to pay the full $1,000 for it if they were able to buy new bonds for $1,000 that paid 6% per year. A second reason why a bond may sell at a discount is that the company or government could be experiencing problems, creating some doubt that it will be able to make the recurring interest payments or have the money needed to repay the face value when the bond matures.
Assuming that the company or government is not in danger of failing, a discount bond’s market value will gradually rise to its $1,000 face value as the maturity date approaches. After all, the company or government will pay $1,000 to the investor who owns it on that date. This gradual increase in value is called accretion. See Accretion to learn more, including the special light in which it is viewed by the government.
Riddle me this:
1. Identify two reasons why a bond might sell for a discount.
2. Which one of these reasons is most troubling to the bond’s owner, and why?
3. What is the name of the gradual rise in market value a discount bond will experience as the maturity date approaches?
Opposite of: Premium bond.