Question

Why do companies issue their bonds at a discount ?

Answer 1

Companies issue Bonds at discount when market rate of interest is more than interest on Bonds issued.

Price of a bond depends on the interest rate given on the bond and the market rate (or effective rate of bond).

Say a company is issuing a bond for $1000 with interest of 10$ per annum but the market rate of interest is 11% per annum on the same $1000.

The investor would want to earn 11% instead of 10% since 11% is higher.

To cover this difference the company issues its bond at discount so that investor may get return equal to what he is getting in market. So the investor will be asked to pay only $ 963 so that he can earn effective 11% on 963.

See the below example to understand this clearly. Assume a bond of 1000 is issued at 10% coupon with market rate 11% for 5 years.

	Annual Rate	Applicable rate		Face Value	$ 1,000.00
Market Rate	11.00%	11.00%		Term (in years)	5
Coupon Rate	10.00%	10.00%		Total no. of interest payments	5

Calculation of Issue price of Bond
	Bond Face Value		Market Interest rate (applicable for period/term)
PV of	$   1,000	at	11.00%	Interest rate for	5	term payments
PV of $1	0.59345
PV of	$   1,000	=	$   1,000	x	0.59345	=	$   593	A
Interest payable per term	at	10%	on	$                1,000
Interest payable per term	$       100
PVAF of 1$	for	11.0%	Interest rate for	5	term payments
PVAF of 1$	3.69590
PV of Interest payments	=	$               100.00	x	3.69590	=		$   370	B
				Bond Value (A+B)			$   963