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Highlights
- A discount bond is sold for less than its principal value.
- Zero coupon bonds are a specific type of discount bond that pay no interest.
- These bonds are typically offered at a reduced price to compensate for the lack of periodic payments.
A discount bond refers to a type of debt security that is sold at a price lower than its face or principal value. The difference between the price at which it is sold, and its face value is the investor’s return. The bond’s face value is paid out when the bond matures, but the investor does not receive periodic interest payments, commonly known as coupons.
One special category of discount bonds is the zero-coupon bond. This type of bond is issued with no coupon, meaning that it does not pay any interest during its life. The bondholder only receives the principal amount at maturity, but the value of the bond is discounted upfront, reflecting the interest that would have been earned. Essentially, zero-coupon bonds are a way of providing returns without regular payments.
Discount bonds can be appealing to certain investors because they allow for the opportunity to buy debt at a reduced price. The return is realized when the bond reaches maturity and the full face value is paid out. This makes them particularly suitable for those who may not need regular income, but instead seek a lump sum payout in the future.
These bonds are often issued by governments or corporations looking to raise funds while avoiding the obligation of paying periodic interest. The primary advantage for issuers is the reduced cost of borrowing compared to bonds that pay regular coupons.
Conclusion
In conclusion, discount bonds offer an investment strategy that provides returns through price appreciation rather than through periodic interest payments. Zero-coupon bonds are a popular variant of discount bonds, and both can be a strategic choice for investors seeking to invest for the long term without the need for regular income.
