A discount bond is a debt security (such as a bond or Treasury bill) that is issued, sold, and traded at a price below its face value. The face value, also known as the par value or principal amount, is the amount the bond will be worth at maturity. The difference between the purchase price (the discounted price) and the face value represents the investor’s return on the investment.

Key features of discount bonds include:

1. **Pricing Below Face Value:**

– Unlike premium bonds that trade at a price higher than their face value, discount bonds are priced below their face value. The discount is the amount by which the purchase price is less than the face value.

2. **Yield to Maturity (YTM):**

– The yield to maturity is the total return an investor can expect to receive if the bond is held until maturity. For discount bonds, the YTM takes into account both the capital gain (the increase in the bond’s value as it approaches maturity) and the periodic interest payments.

3. **Interest Payments:**

– While discount bonds are sold at a price below face value, they typically still pay periodic interest to bondholders. The interest is calculated based on the face value of the bond, and the interest payments are made at regular intervals until maturity.

4. **Maturity Value:**

– At maturity, the bondholder receives the face value of the bond, regardless of the discounted price at which it was originally purchased. The capital gain is realized as the bond approaches maturity.

5. **Example Calculation:**

– Let’s consider a simple example. If a $1,000 face value bond is sold at a discounted price of $900 and pays annual interest of $50, the bondholder receives $50 in interest per year. At maturity, the bondholder receives the full face value of $1,000, resulting in a total return of $1,050.

6. **Zero-Coupon Bonds:**

– Some discount bonds are zero-coupon bonds, meaning they do not make periodic interest payments. Instead, the investor receives the face value at maturity, and the discount represents the implicit interest that accrues over the bond’s term.

7. **Market Conditions:**

– Market conditions, interest rates, and the perceived credit risk of the issuer can influence the pricing of discount bonds. When interest rates rise, the prices of existing bonds may fall, leading to higher discounts.

8. **Risk and Return:**

– While discount bonds can provide capital gains if held to maturity, they also carry risks. Changes in interest rates, credit risk, and economic conditions can affect the market value of discount bonds.

Discount bonds are commonly issued by governments, municipalities, and corporations. Investors may be attracted to discount bonds if they expect interest rates to decline, leading to capital gains as the bond’s market price increases. However, it’s important for investors to carefully consider the risks associated with discount bonds and assess their individual investment goals and risk tolerance.