DEFINITION of 'Accretion of Discount'
Accretion of discount is the increase in the value of a discounted instrument as time passes and the maturity date looms closer. The value of the instrument will accrete (grow) at the interest rate implied by the discounted issuance price, the value at maturity and the term to maturity.
BREAKING DOWN 'Accretion of Discount'
A bond can be purchased at par, at a premium, or at a discount. Regardless of the purchase price of the bond, however, all bonds mature at par value. The par value is the amount of money that a bond investor will be repaid at maturity. A bond that is purchased at a premium has a value above par. As the bond gets closer to maturity, the value of the bond declines until it is at par on the maturity date. The decrease in value over time is referred to as an amortization of premium.
A bond that is issued at a discount has a value that is less than the par value. As the bond approaches its redemption date, it will increase in value until it converges with the par value at maturity. This increase in value over time is referred to as an accretion of discount. For example, a threeyear bond with a face value of $1,000 is issued at $975. Between issuance and maturity, the value of the bond will increase until it reaches its full par value of $1,000, which is the amount that will be paid to the bondholder at maturity.
Accretion can be accounted for using a straightline method, whereby the increase is evenly spread throughout the term. Using this method of portfolio accounting, accretion of discount can be said to be a straightline accumulation of capital gains on a discount bond in anticipation of receipt of par at maturity. Accretion can also be accounted for using a constant yield, whereby the increase is heaviest closest to maturity. The constant yield method is the method required by the Internal Revenue Service (IRS) for calculating the adjusted cost basis from the purchase amount to the expected redemption amount. This method spreads out the gain over the remaining life of the bond, instead of recognizing the gain in the year of the bond’s redemption.
To calculate the amount of accretion, use the formula:
Accretion Amount = Purchase Basis x (YTM / Accrual periods per year)  Coupon Interest
The first step in the constant yield method is determining the yield to maturity (YTM) which is the yield that will be earned on a bond held until it matures. The yield to maturity depends on how frequently the yield is compounded. The IRS allows the taxpayer some flexibility in determining which accrual period to use for computing yield. For example, a bond with a $100 par value and coupon rate of 2% is issued for $75 with a 10year maturity date. Let’s assume it is compounded annually for the sake of simplicity. The YTM can, therefore, be calculated as:
$100 par value = $75 x (1 + r)^{10}
$100/$75 = (1 + r)^{10}
1.3333 = (1 + r)^{10}
r = 2.92%
Coupon interest on the bond is 2% x $100 par value = $2. Therefore,
Accretion_{period1} = ($75 x 2.92%) – Coupon interest
Accretion_{ period1} = $2.19 – $2
Accretion_{period1} = $0.19
The purchase price of $75 represents the bond’s basis at issuance. However, in subsequent periods, the basis becomes the purchase price plus accrued interest. For example, after year 2, the accrual can be calculated as:
Accretion_{period2} = [($75 + $0.19) x 2.92%]  $2
Accretion_{period2} = $0.20
Using this example, one can see that a discount bond has a positive accrual; in other words, the basis accretes, increasing over time from $0.19, $0.20, and so on. Periods 3 to 10 can be calculated in a similar manner, using the former period’s accrual to calculate the current period’s basis.

Constant Yield Method
The constant yield method is one way of calculating the accrued ... 
Current Yield
Current yield is the annual income (interest or dividends) divided ... 
Discount Bond
A discount bond is a bond that is issued for less than its par ... 
Par Value
Par value is the face value of a bond, or for a share, the stock ... 
Accreted Value
Bonds that accrue interest, which is not related to market interest ... 
Accrued Market Discount
Accrued market discount is the gain in the value of a discount ...

Investing
Understanding Bond Prices and Yields
Understanding this relationship can help an investor in any market. 
Investing
Simple Math for FixedCoupon Corporate Bonds
A guide to help to understand the simple math behind fixedcoupon corporate bonds. 
Investing
How Do I Calculate Yield To Maturity Of A Zero Coupon Bond?
Yield to maturity is a basic investing concept used by investors to compare bonds of different coupons and times until maturity. 
Investing
Comparing Yield To Maturity And The Coupon Rate
Investors base investing decisions and strategies on yield to maturity more so than coupon rates. 
Financial Advisor
Calculate PV of different bond type with Excel
To determine the value of a bond today — for a fixed principal (par value) to be repaid in the future — we can use an Excel spreadsheet. 
Investing
4 basic things to know about bonds
Learn the basic lingo of bonds to unveil familiar market dynamics and open to the door to becoming a competent bond investor. 
Investing
Know Your Cost Basis For Bonds
Nobody likes taxes, but tax reporting is an inevitable and unavoidable part of investing. If you buy stock, determining your costs basis is a slightly frustrating but fairly straightforward exercise. ... 
Investing
Top 6 Uses For Bonds
We break down the stodgy stereotype to see what these investments can do for you.

When is a bond's coupon rate and yield to maturity the same?
Find out when a bond's yield to maturity is equal to its coupon rate, and learn about the components of bonds and how they ... Read Answer >> 
Will the price of a premium bond be higher or lower than its par value?
Find out why the selling price of a premium bond is always higher than its par value, including how changing interest rates ... Read Answer >> 
Learn to Calculate Yield to Maturity in MS Excel
Find out the best practices for most financial modeling to price a bonds, calculate coupon payments, then learn how to calculate ... Read Answer >> 
What is the difference between yield to maturity and the spot rate?
Find out how yield to maturity and spot rate calculations use different discount rates to determine the present market value ... Read Answer >>