This allows them to earn a sufficient return on their investment. When interest rates rise above the coupon rate of the bond, the bond will trade at a discount. When bondholders perceive the issuer as being at a higher risk of defaulting on their obligations, they may only be willing to purchase the bonds at a discount. Why a Bond Sells at a DiscountĪ bond may be issued at a discount for the following reasons: 1. Similarly, rising interest rates will result in more bonds trading at a discount of par value. During periods when interest rates are continually falling, bonds will trade at a premium so that the YTM moves closer to the falling interest rates. Similarly, if interest rates drop below the coupon rate, bond prices rise above the par value. If interest rates are higher than the bond’s coupon rate, bond prices must decrease below the par value (discount bond) so that the YTM moves closer to the interest rates. This is because bond prices and YTMs move in opposite directions. With changing interest rates, bond prices must adjust so that their YTM equals or is almost equal to the YTM of new bond issues. If interest rates rise to 4%, the value of the bond will drop, and the bond will trade at a discount. If the prevailing interest rates drop to 2%, the bond value will rise, and the bond will trade at a premium. For example, a bond with a par value of $1,000 and a coupon rate of 3% will pay annual interest of $30. When a new bond is issued, it comes with a stated coupon that shows the amount of interest bondholders will earn. However, the par value will still be repaid to investors when the bond reaches maturity. Bonds trade in the secondary market and their prices change with changes in market conditions. If the bond is offered at $1,030, it is considered to be offered at a premium. If the bond is offered at $970, it is considered to be offered at a discount. Let take an example of a bond with a $1,000 face value. However, it does not necessarily mean it offers better returns than other bonds.
Buying the bond at a discount means that investors pay a price lower than the face value of the bond. The discount takes into account the risk of the bond and the creditworthiness of the bond issuer.Ī discount bond is offered at a lower price than the prevailing market rate. The bond must, therefore, sell at a discount. If interest rates go up, it results in a decline in the value of the bond. However, the value of the bond is likely to increase or decrease with changes in the market interest rates. When an investor purchases a bond, he/she expects to be paid interest by the bond issuer. A bond is considered to trade at a discount when its coupon rate is lower than the prevailing interest rates. It is similar to a zero-coupon bond, only that the latter does not pay interest until maturity. A discount bond is a bond that is issued at a lower price than its par value or a bond that is trading in the secondary market at a price that is below the par value.
0 kommentar(er)
