Bond Discount

A bond discount occurs when a bond's market price falls below its face (par) value, which is typically $1,000. This happens primarily when the bond's coupon rate is lower than current market interest rates — investors are unwilling to pay full price for a below-market coupon. For example, if a bond pays a 3% coupon but newly issued bonds pay 5%, the older bond must trade at a discount to compensate buyers for the lower income stream. The discount narrows as the bond approaches maturity, eventually converging to par value at maturity in a process called "pull to par." Bond discounts can also result from deteriorating credit quality or increased default risk. For tax purposes, the discount on bonds purchased in the secondary market may be treated as ordinary income (market discount) or capital gain depending on how the bond was originally issued and the investor's holding period.