What is a Deep Discount Bond?

A deep discount bond starts its life being sold for much less money than what you’ll get back when it ends. Think of paying $700 today to get $1,000 in five years. The $1,000 is called the par value – it’s what you’re promised at the end. That big difference between the starting price and the ending value makes it a “deep discount.”

How These Bonds Work

The main point of deep discount bonds is getting paid through that big jump in value rather than getting small payments along the way. Regular bonds might pay you bits of money every few months, but deep discount bonds skip all that. You make your money by buying low and getting the full amount later.

Zero-Coupon Bonds – The Most Common Type

Zero coupon bonds are the bonds people usually mean when talking about deep discount bonds. These bonds never pay any small amounts during their life – not even one penny. Instead, you wait until the very end to get all your money at once.

The Difference from Troubled Bonds

Some bonds sell for very low prices because people worry the company might not pay them back. Even though these troubled bonds might be cheap, we don’t call them deep discount bonds. Deep discount bonds are meant to be cheap from the start – it’s part of their design, not because something went wrong.

Why Companies Make Deep Discount Bonds

Companies like deep discount bonds because they don’t have to pay money to investors every few months. This helps when they need time to grow their business before starting to pay people back.

Why People Buy Deep Discount Bonds

Investors buy deep discount bonds when they want to know exactly how much money they’ll make and don’t need regular payments now. Many people use them to save for things far in the future, like paying for their kids’ college or having money for retirement.

The Math Behind the Discount

The size of the discount depends on three things: how long until the bond ends, what interest rates are like right now, and how trustworthy the company is. A longer wait usually means a bigger discount. Higher interest rates also mean bigger discounts. And if the company is very trustworthy, the discount might be smaller because people trust they’ll get paid.

Deep Discount Bonds and Taxes

Taxes on deep discount bonds can be tricky. Even though you don’t get money every year, many places make you pay taxes as if you did. The government acts like you’re earning a bit of that discount every year, even though you won’t see the money until the end.

Risks to Watch For

Deep discount bonds can lose lots of value if interest rates go up. Also, because you wait a long time to get your money, there’s more time for something to go wrong with the company. Some people also find it hard to wait years without getting any payments along the way.