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. Pension Risk Transfer

    When a defined benefit pension provider offloads some or all of the plan’s risk – e.g.: retirement payment liabilities to former employee beneficiaries. The plan sponsor can do this by offering vested plan participants a lump-sum payment to voluntarily leave the plan, or by negotiating with an insurance company to take on the responsibility for paying benefits.
  2. XW

    A symbol used to signify that a security is trading ex-warrant. XW is one of many alphabetic qualifiers that act as a shorthand to tell investors key information about a specific security in a stock quote. These qualifiers should not be confused with ticker symbols, some of which, like qualifiers, are just one or two letters.
  3. Quanto Swap

    A swap with varying combinations of interest rate, currency and equity swap features, where payments are based on the movement of two different countries' interest rates. This is also referred to as a differential or "diff" swap.
  4. Genuine Progress Indicator - GPI

    A metric used to measure the economic growth of a country. It is often considered as a replacement to the more well known gross domestic product (GDP) economic indicator. The GPI indicator takes everything the GDP uses into account, but also adds other figures that represent the cost of the negative effects related to economic activity (such as the cost of crime, cost of ozone depletion and cost of resource depletion, among others).
  5. Accelerated Share Repurchase - ASR

    A specific method by which corporations can repurchase outstanding shares of their stock. The accelerated share repurchase (ASR) is usually accomplished by the corporation purchasing shares of its stock from an investment bank. The investment bank borrows the shares from clients or share lenders and sells them to the company.
  6. Microeconomic Pricing Model

    A model of the way prices are set within a market for a given good. According to this model, prices are set based on the balance of supply and demand in the market. In general, profit incentives are said to resemble an "invisible hand" that guides competing participants to an equilibrium price. The demand curve in this model is determined by consumers attempting to maximize their utility, given their budget.
Trading Center