Discount

DEFINITION of 'Discount'

In finance, discount refers to the condition of the price of a bond that is lower than par, or face value. The discount equals the difference between the price paid for a security and the security's par value.

BREAKING DOWN 'Discount'

For example, if a bond with a par value of $1,000 is currently selling for $990 dollars, it is selling at a discount of 1%, or $10. The reason for the discount is that it has a lower interest rate than the market value—in other words, since it's not paying as high of an interest rate to the holder, it must be sold at a lower price to be competitive, or else no one would buy it. This interest rate, known as a coupon, is generally paid on a semiannual basis. The term coupon comes from the days of physical bonds (as opposed to electronic ones), when some bonds had coupons attached to them. Some examples of discount bonds include U.S. savings bonds and U.S. Treasury bills.

Stocks and other securities can similarly be sold at a discount. However, this discount is not due to interest rates; rather, a discount is usually implemented in the stock market in order to generate buzz around a particular stock, and the par value only specifies the minimum price the security can be sold for upon its initial entrance into the market.

Deep Discounts and Pure Discount Instruments

One type of discount bond is a zero-coupon bond, which doesn't pay interest but instead is sold at a deep discount. This discount amount is equal to the amount lost by a lack of interest payments. Zero-coupon bond prices tend to fluctuate more often than bonds with coupons.

A deep discount doesn't only apply to zero-coupon bonds; it is generally considered to apply to any bonds that are 20% below market value and beyond.

Another type of discount bond is a pure discount instrument. This bond or security pays nothing until maturity. This type of bond is sold at a discount, but when it reaches maturity, it pays the par value. For example, if you purchase a pure discount instrument for $900 and the par value is $1,000, you'll get $1,000 when the bond reaches maturity.

Discounts vs. Premiums

A discount is the opposite of a premium, which applies when a bond is sold for higher than par value. Using the above example, a premium occurs if the bond is sold at, for instance, $1,100 instead of its par value of $1,000. Conversely to a discount, a premium occurs when the bond has a higher interest rate than the current market value. To learn more about the payout on bonds in relation to discounts and premiums, see: If the price of the bond falls, does that mean the company won't pay me the par value?

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