Definition of Shallow Discount Bond
A shallow discount bond is a type of bond issued in the primary market at a price that is more than 90% of its face value. This indicates that the bond is being sold at a slight discount, not exceeding 10% of its par (face) value. Typically, these bonds are considered to have lower risk compared to deeply discounted bonds (where the discount exceeds 10%), making them attractive to conservative investors who are looking for moderate yield coupled with relative safety.
Key Features:
- Issuance Price: More than 90% of face value.
- Discount: Does not exceed 10%.
- Risk Level: Generally lower compared to deeply discounted securities.
- Issuance Market: Sold in the primary market where new securities are issued.
Examples
- Example 1: A bond with a face value of $1,000 is issued at $950. The discount here is $50, or 5%, making it a shallow discount bond.
- Example 2: A corporate bond with a face value of $5,000 is issued at $4,700. The discount is $300, or 6%, classifying it as a shallow discount bond.
- Example 3: A government bond with a face value of $10,000 is issued at $9,200. The discount is $800, or 8%, which fits the definition of a shallow discount bond.
Frequently Asked Questions (FAQs)
Q1: Why would an investor choose a shallow discount bond over a par bond? A: Investors might choose a shallow discount bond if they wish to purchase bonds at a slight discount for a modest yield advantage while aiming to minimize the risk, as these bonds are relatively safer compared to deeply discounted bonds.
Q2: How does the yield of a shallow discount bond compare to a coupon bond? A: The yield of a shallow discount bond is typically slightly higher than a coupon bond sold at par because the investor is paying less than the face value but will receive the full face value at maturity.
Q3: Are shallow discount bonds more sensitive to interest rate changes? A: Yes, like all bonds, shallow discount bonds are sensitive to interest rate changes. The smaller the discount, the less sensitive it generally is compared to more deeply discounted bonds.
Q4: How do I benefit if I hold a shallow discount bond to maturity? A: If held to maturity, you will receive the bond’s face value, which includes the slight appreciation from the discount you purchased it at, plus any coupon payments received during the holding period.
Q5: Can shallow discount bonds be traded in secondary markets? A: Yes, after their issuance in the primary market, shallow discount bonds can be traded in secondary markets where their prices may fluctuate based on prevailing interest rates and market conditions.
Related Terms with Definitions
- Primary Market: The market where new securities are issued and sold for the first time.
- Deeply Discounted Security: A security issued at a significant discount to its face value, typically more than 10%.
- Par Value (Face Value): The nominal value of a bond that is returned to the bondholder at maturity.
- Coupon Rate: The interest rate paid by the bond issuer on the bond’s face value.
- Yield: The return an investor receives on a bond, factoring in the purchase price, par value, coupon interest payment, and time to maturity.
Online References
Suggested Books for Further Studies
- “The Bond Book” by Annette Thau - A comprehensive guide to bond investing, including different types of bonds such as shallow discount bonds.
- “Fixed Income Analysis” by Frank J. Fabozzi - An in-depth look at fixed income securities including detailed concepts on bond pricing, issuance, and trading.
- “Investing in Bonds For Dummies” by Russell Wild - An accessible guide for beginners to understand the bond market, including primary market instruments.
Accounting Basics: “Shallow Discount Bond” Fundamentals Quiz
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