What is a Deep Discount Bond?

A deep discount bond is a bond that is trading at a substantial discount from its face value. One reason for the deep discount is that the stated interest rate on the bond is well below the current market rate. Another possible reason is that the issuer has quite a low credit rating, so that investors demand a high effective interest rate in order to hold the issuer’s bonds. The prices of deep discount bonds tend to fluctuate more widely than the prices of bonds that trade closer to their face values.

Advantages of Deep Discount Bonds

There are several advantages to investing in deep discount bonds, which are as follows:

Potential for high returns. Since these bonds are sold at a significant discount, there is potential for substantial price appreciation if the bond is held to maturity. Investors can buy them at a low price and receive the face value upon maturity, potentially earning a high effective return.
Lower initial investment. Deep discount bonds allow investors to enter at a lower cost, making them more accessible than other bonds with higher purchase prices. This can appeal to individual investors or those with limited initial capital.
Lower interest rate risk. Deep discount bonds generally have a fixed payout at maturity, which makes them less sensitive to interest rate fluctuations compared to regular bonds that pay periodic interest. If held to maturity, the investor is less impacted by market interest rate changes.
High yield opportunity. In environments where traditional bond yields are low, deep discount bonds provide an opportunity for higher yields. This can make them attractive during periods of low interest rates when fixed-income investors seek better returns.

Disadvantages of Deep Discount Bonds

The main concern with deep discount bonds is the high risk of default associated with them. Investors could lose their entire investments in these bonds if the issuer were unable to redeem them.