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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?

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    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,
    Your BrainMass Academic Expert

    a. What is a discount bond? What will happen to the price of a discount bond as it
    approaches maturity?
    A discount bond is a bond selling below par (face value). Face value is always $1,000 unless otherwise stated. Thus, the current price of a discount bond is below $1,000. As the bond approaches maturity, its current price will gradually shift upwards, reaching $1,000 when the bond matures.
    Bonds are usually issued at the market interest rate. As time goes ...

    Solution Summary

    This solution includes the definition of a discount bond and explanations what happens to the current price of a bond when the market rates fluctuate or when time to maturity changes. Some examples are provided to clarify the explanations. Attached in Word.