Question

An investor is looking through various bond alternatives for potential investment. She has noticed a large number of them are currently selling for less than their original par value and is confused and nervous as to what this may mean for her potential investment if she purchases one of these. Please describe how and why these type of situations occur.

Answer 1

These types of bonds are called discount bonds when they sell for lesser than the par value.

When bond prices and yield change, they serve as an important indicator for an investor. When the bonds are selling for lesser than the par value, one of the reasons could be that seller believes that the future outlook of the company is negative and company is not able to adequately finance it's security.

The pros of buying such bonds are that the chances of appreciation in value of such bonds are fairly high as long as seller doesn't default. Even if it is held till the maturity , the buyer will be gaining the principal value which is still an appreciation from the discounted price. Only problem with such bonds are higher probability of default by such offering companies.

These type of situation occur when the credit risk associated with the issuer company is high and sellers of the bonds believe in a negative outlook for the company so they dump their bonds before maturity at discount as they believe company is going to default.