Deep-Discount Bond

What Is a Deep-Discount Bond?

A deep-discount bond is a bond that sells at an essentially lesser value than its par value. In particular, these bonds sell at a discount of 20% or more to par and has a yield that is fundamentally higher than the overarching rates of fixed-income securities with a comparative profiles.

These high-yield or junk bonds will generally have low market prices due to underlying worries about the issuers ability to repay interest or principal on the debt. This isn't generally the case be that as it may, as zero-coupon bonds will frequently start trading at a deep-discount even in the event that the issuer is highly rated in terms of credit quality.

Seeing Deep-Discount Bonds

At the point when a bond develops, the investor is reimbursed the full face value of the bond. A bond can be sold at par, at a premium, or at a discount. A bond purchased at par has a similar value as the face value of the bond. A bond purchased at a premium has a value that is higher than the par value of the bond. Over the long run, the value of the bond diminishes until it equals the par value at maturity. A bond issued at a discount is priced below par. A type of discount bond traded in the markets is the deep-discount bond.

A deep discount bond will typically have a market price of 20% or more below its face value. An issuer of a deep discount bond might be perceived to be financially unsound. The bonds issued by these organizations are believed to be riskier than comparable bonds and are, in this manner, priced likewise. Junk bonds are instances of deep-discount bonds. Bondholders may likewise end up holding deep-discount bonds when the credit rating of the responsible company is unexpectedly downsized.

A bond may likewise be issued at a huge discount if the initial coupon rate on the bond is offered at a fundamentally lower than the going interest rate in the market, making it less appealing to investors who can find better interest rates somewhere else. Since the price of a bond is conversely connected with interest rates, an increase in interest rates will mean that the coupon rate of existing bonds isn't on par with fresher bonds issued at the higher interest rate. Holders of these lower coupon bonds will, thusly, see the value of their bonds fall. The reduction in value mirrors the way that the predominant interest rates are higher than the coupon rates on the bond. In the event that interest rates increase sufficiently high, the value of the bond might fall up to this point that it is offered at a deep discount.

Deep-Discounts and Zero-Coupon Bonds

A deep discount bond doesn't need to pay coupons, as seen with zero-coupon bonds. A few zero-coupon bonds are offered at a deep discount, and these bonds don't make periodic payments to bondholders. The yield on these bonds is the difference between the par value and the discounted price. This means that the price of zero-coupons will vacillate more than bonds that give periodic interest payments. Each of the zero-coupon bonds are not deep-discount bonds; some are original issue discount (OID) bonds. For instance, an OID bond might be one issued at $975 with a $1,000 par value, and a deep-discount bond might be one issued at $680 with a $1,000 par value.

Deep-discount bonds are typically long term, with maturities of five years or longer (aside from Treasury bills which are short-term zero-coupon), and are issued with call provisions. Investors are drawn to these discounted bonds in light of their high return or negligible chance of being called before maturity. Issuers look for the least cost method of raising capital through debt. Deep discount bonds appreciate quicker than different types of bonds when market interest rates fall and devalue quicker when the rates rise. On the off chance that interest rates increase in the economy, the existing bonds will carry lower interest payments and, hence, a lower cost of debt to the issuer. It will, subsequently, be in the issuer's best financial interest to not call the bonds.

Highlights

• A deep-discount bond trades at a market price that is 20% or lower than its par or face value.
• Zero-coupon bonds will likewise be issued at a deep-discount, even on the off chance that the issuer is of the highest credit ratings, since these bonds don't pay coupons and will increase in value as they approach maturity.
• These discounts might reflect underlying credit worries with the issuer, expanding the yields on these bonds to junk level as the risk of default increases.