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. Cash and Carry Transaction

    A type of transaction in the futures market in which the cash or spot price of a commodity is below the futures contract price. Cash and carry transactions are considered arbitrage transactions.
  2. Amplitude

    The difference in price from the midpoint of a trough to the midpoint of a peak of a security. Amplitude is positive when calculating a bullish retracement (when calculating from trough to peak) and negative when calculating a bearish retracement (when calculating from peak to trough).
  3. Ascending Triangle

    A bullish chart pattern used in technical analysis that is easily recognizable by the distinct shape created by two trendlines. In an ascending triangle, one trendline is drawn horizontally at a level that has historically prevented the price from heading higher, while the second trendline connects a series of increasing troughs.
  4. National Best Bid and Offer - NBBO

    A term applying to the SEC requirement that brokers must guarantee customers the best available ask price when they buy securities and the best available bid price when they sell securities.
  5. Maintenance Margin

    The minimum amount of equity that must be maintained in a margin account. In the context of the NYSE and FINRA, after an investor has bought securities on margin, the minimum required level of margin is 25% of the total market value of the securities in the margin account.
  6. Leased Bank Guarantee

    A bank guarantee that is leased to a third party for a specific fee. The issuing bank will conduct due diligence on the creditworthiness of the customer looking to secure a bank guarantee, then lease a guarantee to that customer for a set amount of money and over a set period of time, typically less than two years.
Trading Center