Market Discount

Definition of 'Market Discount'


The difference between a bond's stated redemption price and its purchase price on the secondary market, if it has been purchased at a price below par. Market discount arises when a bond's value on the secondary market decreases after it has been issued, usually because of an increase in interest rates. In the case of original issue discount (OID) securities such as zero-coupon bonds, the market discount is the difference between the purchase price and the issue price plus accrued OID.

Investopedia explains 'Market Discount'




Market discount is not subject to taxation annually in the U.S., but it becomes taxable as ordinary interest income in the year that the bond is sold or redeemed. The bond investor can also elect to include amortized market discount annually in income for tax purposes, although this would mean paying tax on it now rather than in the future. Note that market discount is taxable even if regular interest income from the bond in question is tax-exempt, such as for municipal securities.

For example, assume that a U.S. investor pays $900 for a bond that was originally issued with a par value of $1,000. The $100 difference between the par value and the purchase price is the market discount. It will have to be reported as ordinary interest income on the investor’s tax return either upon disposition or annually on an amortized basis, depending on the election made by the investor.

There are certain exceptions to the election rules, such as for short-term obligations that mature in one year or less from the date of issue, and U.S. savings bonds. As well, for tax-exempt bonds purchased before May 1, 1993, a gain arising from a market discount is treated as a capital gain rather than interest income.

Another exemption to the election of how market discount should be treated for tax purposes relates to “de minimis” or small market discounts. Under the “de minimis” rule, the market discount is treated as zero if the amount of the discount upon purchase is less than 0.25% of the bond's face value, multiplied by the number of full years from the time of purchase to the maturity date. If the market discount is less than the de minimis amount, the market discount would have to be treated as a capital gain – rather than ordinary income – when the bond is sold or redeemed.

As an example, if you buy a bond with a $1,000 par value maturing in 10 years for $985, the market discount is $15. Since this discount is less than the de minimis threshold of $25 (0.25% of $1,000 x 10 = $25), the market discount is considered to be zero. As a result, the $15 discount will be treated as a capital gain when you sell or redeem the bond.


Filed Under: ,

comments powered by Disqus
Hot Definitions
  1. Oil Reserves

    An estimate of the amount of crude oil located in a particular economic region. Oil reserves must have the potential of being extracted under current technological constraints. For example, if oil pools are located at unattainable depths, they would not be considered part of the nation's reserves.
  2. Joint Venture - JV

    A business arrangement in which two or more parties agree to pool their resources for the purpose of accomplishing a specific task. This task can be a new project or any other business activity. In a joint venture (JV), each of the participants is responsible for profits, losses and costs associated with it.
  3. Aggregate Risk

    The exposure of a bank, financial institution, or any type of major investor to foreign exchange contracts - both spot and forward - from a single counterparty or client. Aggregate risk in forex may also be defined as the total exposure of an entity to changes or fluctuations in currency rates.
  4. Organic Growth

    The growth rate that a company can achieve by increasing output and enhancing sales. This excludes any profits or growth acquired from takeovers, acquisitions or mergers. Takeovers, acquisitions and mergers do not bring about profits generated within the company, and are therefore not considered organic.
  5. Family Limited Partnership - FLP

    A type of partnership designed to centralize family business or investment accounts. FLPs pool together a family's assets into one single family-owned business partnership that family members own shares of. FLPs are frequently used as an estate tax minimization strategy, as shares in the FLP can be transferred between generations, at lower taxation rates than would be applied to the partnership's holdings.
  6. Yield Burning

    The illegal practice of underwriters marking up the prices on bonds for the purpose of reducing the yield on the bond. This practice, referred to as "burning the yield," is done after the bond is placed in escrow for an investor who is awaiting repayment.
Trading Center