Question

Describe a bond issued at a discount. Explain why an investor would purchase a bond issued at a discount instead of a bond issued at par or a bond issued at a premium. (Review pages 515 to 520)

Answer 1

Describe a bond issued at a discount:

Explanation:

1) When bond is issued less than its par value its said to be discount bond.

2) So, discount bond is one trading below its face value.

3) Generally , a par value of bond is $ 100, but when it is issued less than this amount in secondary market , it is referred as a discount bond.

2) why an investor would purchase a bond issued at a discount instead of a bond issued at par or a bond issued at a premium.

Explanation:

1) Bond prices move in the opposite direction of interest rates:

When interest rates rise, bond prices fall, and vice versa.

2) A bond will trade at a discount when it offers a coupon rate that is lower than prevailing interest rates.

3) Since investors always want a higher yield, they will pay less for a bond with a coupon rate lower than the prevailing rates

4) So they are buying it at a discount to make up for the lower coupon rate.

5) Bond has fixed interest,so When bond prices change, the amount of interest payments remains the same, but its yield - the actual return an investor will get on his money - will change.

6) Ex . when bond is issued at par and rate is 5%

Interest paid = $ 1000 × 5% = $ 50

return = $50/ 1000 = 5%

7) When bond is issued at 96 , than also interest amount would be fix i.e. $50 only return is changed

Here, return = $50/960= 5.2%

8) Regardless of what investor has paid for a bond, at maturity they will get back its full face value. If investor buy a discount bond, they will have a capital gain

9) for all the above mention reason,

investor would purchase a bond issued at a discount instead of a bond issued at par or a bond issued at a premium