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Discount Bond: Definition, Properties, and Examples

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a. What is a discount bond? What will happen to the price of a discount bond as it
approaches maturity?

1- Given TWO (2) identical bonds with the same coupon rate but different maturity dates,
the bond with a longer maturity date is said to be more risky than the bond with a shorter
maturity date. Why?

2- A bond is called a discount bond when the selling price is lower than its par value.
Theoretically, why do discount bonds exist?

3- An increase in interest rate will result in a fall in bond prices. But the price change
experienced by a bond with low coupon rate will be much more than that of a bond with
high coupon rate. Why is this so?

Solution Preview

Dear Student,

The explanations on bonds below are in blue. The calculated examples are meant to clarify the explanations. In the examples, N = number of years to maturity, I = market interest rate (or yield to maturity, assuming we hold the bond until maturity), PMT = coupon interest rate (in dollars), and PV = current price of the bond. A financial calculator has been used in computations.

Best regards,