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Definition: Deep Discount Bond
Most of the bonds make periodic coupon payments but there are a few bonds known as “Deep-discount bonds” (also known as ‘Zero Coupon Bonds’) where the bonds are not contracted to make periodic coupon payments.
Here the holder of the bonds earns income by buying the bond at a rate which is substantially lower than its par value. I.e. he buys the bond at a “DEEP-DISCOUNT”. The bond holder earns this income only on the maturity date when the company redeems these bonds either at the par value or at premium.
Therefore the interest (income) earned here is the difference between the par value and the discounted rate at which bondholder buys the security.
Example: If the bondholder purchases a deep-discount bond of par value Rs.1000 at Rs. 860, then the interest earned during redemption is Rs. 140 (Rs. 1000 – Rs. 860).