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Deep Discount Bonds

Moneyzine Editor
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Moneyzine Editor
2 mins
January 15th, 2024
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Deep Discount Bonds

Definition

The financial accounting term deep discount bonds refers to indentures that are sold at a price significantly lower than face value, typically 20% or more. Deep discount bonds can also include zero coupon bonds, which do not pay a rate of interest to the holder.

Since deep discount bonds are usually issued for a term of five years or more, they represent a long term obligation of the company, and are shown in the long term liabilities section of the balance sheet.

Explanation

Issuing long-term bonds represents an important source of financing for many large companies. Deep discount bonds typically carry maturities of five years or longer and are classified as long-term debt obligations. (Treasury bills are one exception to the above rule, maturing in as few as 28 days.)

Generally, deep discount bonds take one of two forms:

  • Interest Bearing Debt: these indentures provide the investor with periodic interest payments; however, the security is sold at a discount of 20% or more from the bond's par value. This can occur because the coupon rate on the bond is considerably lower than prevailing rates offered by securities of similar risk. This will oftentimes happen when interest rates are rising, whereby newly issued securities carry higher coupon rates. A deep discount can also be the result of an increase in the risk of non-payment, or credit risk.

  • Zero Coupon Bonds: these securities do not provide the investor with periodic interest payments. Instead, they are sold at a discount to par value, and provide the investor with a return as calculated by its yield to maturity. Zero coupon bonds are favored by investors that do not need a near term source of income, but have a longer-term goal. Since this bond's yield is solely based on the difference between the market price and its face value, its price will fluctuate more than bonds that provide periodic interest payments too.

Related Terms

  • Liabilities
    The financial accounting term liability is used to describe the debt of a corporation that results from a transaction involving the transfer of an asset or the provision of a service. Liabilities are reported on a company's balance sheet.
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  • Long-Term Debt
    The financial accounting term long term debt is defined as the loans and other debt obligations of a business that are payable in twelve months or longer. Long term debt appears in the liabilities section of a company's balance sheet.
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  • Interest Expense
    The financial accounting term interest expense is used to describe the interest payments that have come due on amounts borrowed by a company or an individual. Interest expense will appear as a line item on a company's income statement.
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  • Commodity-Backed Bonds
    The term commodity-backed bonds refers to debt securities that are linked to the price of a commodity. These securities are typically issued in one of two ways. The rate of interest paid on the bond can change as the price of the commodity fluctuates. Alternatively, the face value of the bond can increase or decrease as the price of the commodity changes.
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  • The financial accounting terms registered and bearer bonds refer to the indication and method of ownership associated with the security. With registered bonds, the owner's name and contact information is kept on file with the issuing company. Bearer bonds do not have registered owners on file with the issuing company, and are considered owned by whoever is in possession of the certificate.
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  • Accrual Bond
    The term accrual bond refers to a security that does not make periodic interest payments to the bondholder. As interest accrues, it is added to the principal of the bond and paid to the investor when the security matures.
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  • Adjustment Bond
    The term adjustment bond refers to a security issued when a corporation is recapitalized during a bankruptcy proceeding. Adjustment bonds are issued in exchange for the outstanding debt of an organization, typically with terms that will help the corporation successfully emerge from bankruptcy.
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  • Agency Security
    The term agency security refers to bonds issued or guaranteed by a federal agency or those issued by a government-sponsored enterprise. Agency securities are considered low risk investments.
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